China ’steals U.S. thunder’ ahead of G20

China’s announcement that it will introduce more flexibility into its exchange rate is a deft political move amid rising international criticism of Beijing, but the economic implications are much less certain.

Although Chinese officials insisted on Sunday that the decision was taken for domestic reasons, the announcement comes a week ahead of a G20 summit in Canada that was shaping up to be something of a showdown over the level of the Chinese currency.

By indicating that the peg between the renminbi and the US dollar was now likely to be broken, Beijing had “stolen the thunder” from the US and other governments that hoped to use the summit to put pressure on China, said Eswar Prasad, a former IMF China economist now at Cornell University. “They have taken the issue right off the table for the G20 and can refocus attention on what they see as the real problem for global financial stability — rising government debt in the advanced economies, especially the US.”

Indeed, as criticism in the US of China’s undervalued currency has been on the rise, Beijing has argued that the US economy is the real problem. “What they are doing with their own currency will affect the global economy much more than anything else,” one senior government official said last week.

China’s currency move: Why now?

This is not the first time that Beijing has used carefully timed announcements to deflect attention from its policies. Ahead of last April’s G20 summit, when China’s large current account surplus was under attack, Zhou Xiaochuan, central bank head, called for the replacement of the US dollar as the global reserve currency. That proposal had the desired political effect of shifting the focus back to the US economy.

Li Daokui, an adviser to the Chinese central bank, added that Beijing was shifting policy now on its own terms because it did not want to be cornered into a Plaza Accord-style negotiation. (In 1985, the governments of France, West Germany, Japan, the US and the UK, agreed to let the dollar depreciate in relation to the yen and D-Mark by intervening in currency markets. The accord was signed at the Plaza Hotel in New York City.)

If the political intentions of the weekend statement are clear, the economic consequences are not so obvious. The central bank ruled out the two things that had been expected — a sizeable one-off appreciation and a widening of the bands between which the currency trades.

The implication is that Beijing will return to a pre-crisis policy of a crawling peg against the US dollar, possibly starting on Monday.

Obama praises China’s move to allow its currency to float

Beijing has plenty of excuses for caution. China’s exchange rate against the euro has already appreciated 15 per cent in recent months, raising worries about slowing exports to China’s biggest market. Inflation in China is higher than most of its trading partners, meaning that China’s real exchange rate is also rising.

Moreover, Chinese officials point to the sharp drop in the country’s current account surplus as evidence that substantial rebalancing of the economy is already taking place.

Andy Rothman, an economist at CLSA in Shanghai, said he expected appreciation against the US dollar in the short term of 0.2 per cent a month — well short of the likely level needed to appease critics in the US and elsewhere

Mr Li said the greater “flexibility” in the exchange rate could potentially include occasional periods of depreciation against the dollar.

The Chinese authorities are aware of the risk of setting up a “one-way bet” on the currency that ends up attracting capital inflows into the economy. By stressing that the renminbi will be managed against a basket of currencies, they have an excuse to weaken the currency against the dollar and punish speculators if the euro continues to depreciate.

“The greater two-way volatility between the renminbi and the dollar will help mitigate hot money inflows,” said Jun Ma, an economist at Deutsche Bank.

Just as before Saturday’s announcement, therefore, China’s currency policy will depend heavily on what happens in Europe over the coming months.

The central bank, which has been battling to strengthen the renminbi for some time in order to cool the economy and give it more control over monetary policy, has won a tactical victory over pro-export lobbies.

If the situation in Europe stabilises, the central bank could yet secure the political backing to resume a more decisive path of appreciation against the dollar. But until then, analysts say, its hands are likely to remain tied, despite the powerful political punch of its weekend announcement.