Special Report-Will China’s trade deficit derail Yuan revaluation?
Monday, April 12th, 2010China posted a $7.24bln trade deficit in March. This was the first monthly trade deficit for China in almost 6 years. The deficit reflects weaker export sales to the US, rising energy costs and a surge in raw material prices. Exports rose by 24.3% and imports surged 66%. China’s minister of commerce said that the monthly deficit was a blip on the radar screen and that import and export levels were higher than March of 2008. According to the WSJ the Chinese trade deficit could ease pressure on China to make a change its currency policy and complicate efforts to persuade China to revalue the Yuan. It is not clear if today’s announcement of China’s trade deficit will be a barrier to reform of its currency regime.
Numerous reports suggest that China is on the verge of allowing a gradual appreciation of the Yuan. It seems that everyone has an opinion about Yuan revaluation and here is mine. First some background on the Yuan revaluation debate. The record global trade imbalance is seen as a reflection of China’s keeping the Yuan artificially low which encourages US and global demand for China’s goods. China intervenes to keep its currency undervalued to make Chinese exports more competitive. At the same time the US continues to borrow to buy Chinese imports. China’s economy relies heavily on export sales. The US relies heavily on China for cheap imports and to fund its debt. This contributes to the widening of the global trade imbalance and is seen as unsustainable. A number of economists believe that Yuan revaluation would help redress global trade imbalance buy leveling the playing field and force China to boost consumption and domestic demand. International pressure for Yuan valuation has intensified as the U.S. Congress prepares its semiannual currency report.
Some members of the U.S. Congress call for China to be named a currency manipulator if China does not take action to allow its currency to appreciate. Congress may also consider imposing trade sanctions on China. China would likely retaliate should the US name China a currency manipulator and impose sanctions. This could contribute to a rise in protectionism. Rising protectionism would be a major threat to the global recovery. The Congressional semiannual currency report will be delayed a month as US officials try to persuade China to allow the Yuan to be revalued. Last week the New York Times reported that the Chinese government is close to announcing a shift in it’s currency policy and that China will soon allow a gradual Yuan revaluation. The Chinese president will meet with US officials later this week and there is hope that this meeting may help to resolve US/Chinese tensions over the Yuan. Chinese officials have sent mixed signals in regard to the possibility of Yuan revaluation. China’s Prime Minister Wen has indicated that China will not buckle to international pressure to revalue its currency. PBOC officials indicate that China could move to a managed float.
Because China fixes the value the Yuan it is difficult for China’s central bank to control China’s money supply. The current strength of China’s economic recovery contributes to a sharp increase in domestic growth, a surge in the money supply and inflationary pressures in the real estate market. In an effort to slow inflationary pressures China has increased its reserve ratio and taken actions to curb lending. If China allows the Yuan to revalue it will give the Chinese central bank an additional tool to help to curb inflationary pressures and allow the Chinese central bank to have greater influence over the money supply. This could help China avoid asset bubbles. Yuan revaluation would also contribute to cheaper imports, reduce the cost of China’s foreign debt obligations and help make the Chinese economy become more productive and less dependent on exports. The main negative of Yuan revaluation for China is that it could contribute to slower growth and weaker export sales. The impact of Yuan revaluation for China’s economy should be modest because any shift in its currency policy would be small and change would gradual.
What are some of the possible implications of Yuan revaluation for the Forex market? Yuan revaluation could be a modest positive for JPY and Asian currencies. JPY sometimes is used as a proxy for Yuan revaluation and Yuan revaluation could make Japan and other Asian nation’s exports more competitive. Japan and other Asian nations would likely intervene to try to prevent any significant appreciation of their currencies should China revalue Yuan. Therefore the impact Yuan reevaluation for JPY and Asian currencies could be limited. Yuan revaluation could be a negative for the EUR. China’s reserves rose to a new high of $2.4trln at the end of March. China is the US government’s biggest foreign creditor. China buys US bonds (USD) to help manage its Yuan peg. This contributes to China’s accumulation of USD reserves. China has been diversifying some of its reserve holdings into the EUR and other currencies. Yuan revaluation would reduce China’s need to rebalance reserves into the EUR and other currencies and the USD may benefit. In addition Yuan revaluation makes it cheaper for China to buy US bonds, another positive for the USD. The impact of Yuan revaluation on the commodity currencies is not clear. Yuan revaluation would tighten monetary conditions. Tightening of monetary conditions could slow global growth and demand for commodities. Yuan valuation could also be a boon for commodity demand as stronger the Yuan makes it cheaper for China to buy commodities.
If China wants to become more influential on the global financial stage it will need to lay the foundation for the Yuan to emerge as a global currency. This means Yuan revaluation at some point seems inevitable. China has kept the Yuan pegged at 6.83 per USD since July of 2008. The Yuan peg was used to help China’s exporters weather the global downturn that emerged after the Lehman Brothers crisis. With the worst of the credit crisis passed and China’s growth accelerating Chinese officials should be more willing to consider Yuan revaluation. Yuan revaluation would help China’s economy become more productive and reduce reliance on exports for growth. Despite today’s announcement of the first Chinese trade deficit in six years we expect China will announce a shift in its currency policy in the coming months and let the Yuan gradually appreciate. China is unlikely to announce a major shift in its Yuan policy because it could hurt China’s exporters. China may use the March trade deficit to deflect criticism about its currency policy but the deficit is not likely to derail Yuan revaluation.
Written by Easy-Forex
