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The Chinese puppet dance

A managed float of the yuan gives Asian economies more room to manoeuvre.

india Updated: Jun 23, 2010 23:47 IST

China is back to a managed float of its currency, the yuan, on the eve of a meeting of the world’s 20 biggest economies that have been trying to wean Beijing off the dollar peg. The US, due for elections to its Congress later this year, faces politically ruinous unemployment rates and is leading the charge against trade distorting ‘currency manipulation’ that has created a Chinese foreign exchange reserve of $2.5 trillion — essentially the consumption the Chinese have forgone over decades in their effort to flood the world with cheap goods. China’s export-led model, on the other hand, needs active currency support and its political bosses are unlikely to ease off because high growth rates are keeping unrest at bay in a nation without adequate social security. Besides, China and the rest of Asia are partly funding the West’s recovery through their voracious appetite for US debt. A significant abatement here could raise global borrowing costs.

For the moment, the Chinese have blinked, but it is unlikely the yuan will rise to levels that can reverse the global trade imbalance. A return to managed float is by far a better alternative to the risk of a trade war. Beijing does seem to appreciate the responsibility thrust upon it in the new global order after the Crash of 2008. Its challenge is to devise a way to return to sustained, rapid growth in an environment of softer Western demand. The structural shift requires wider social security to discourage precautionary savings, more robust financial markets to lessen the dependence on foreign capital and flexible exchange rates to restore the global trade balance. China’s, and by extension Asia’s, longer-term growth prospects may be determined by its ability to recalibrate the drivers of growth to allow domestic sources to play a more dynamic role.

The immediate impact of a rising yuan on other Asian currencies, including the rupee, is the room it allows for them to appreciate without hurting competitiveness. Around two-thirds of Chinese exports are imported raw material or intermediate goods from Asia, which stands to gain from Beijing’s currency reform. Chinese exports may become dearer in dollar terms but the decline in import prices ought to limit the price rise. Central bankers across Asia will be watching the yuan closely now to get a fix on the degree of forex market intervention required of them. Rising Asian currencies provide policy-makers in the continent an indirect tool to tighten the domestic economy without hiking interest rates aggressively.