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What the rebalancing of the renminbi really means Print E-mail
Monday, 21 June 2010

By Nick Lord

The news over the weekend that China was introducing more 'flexibility" to its currency regime shows how much the country is internationalizing, especially in its trading with other countries. In the mid 2000s, trade with China was still essentially offshore; transactions were conducted in dollars; Chinese importers had to deposit those dollars with state institutions such as the banks or the State Administration of Foreign Exchange and receive renminbi (RMB) back at a fixed rate. Foreign exporters had very little exposure to the Chinese currency itself.

In July 2005 however, the country moved to pegging its currency to a basket of other currencies, while also revaluing the RMB upwards against the dollar by 2 percent. This regime was reversed in 2008 during the crisis, when the RMB was re-pegged to the dollar at a rate of RMB6.83 to $1.

The announcement over the weekend means the RMB will now be valued against a basket of currencies again, and it will be allowed to move by a prescribed amount every year. This regime is pretty much a carbon copy of that which controls the Singaporean dollar and so is a tried and tested model. But it will also emphasize the trend of the RMB becoming an international currency. In recent years, China has allowed trade between itself and other Asian countries to be conducted in RMB and not dollars. International banks in countries surrounding China now offer RMB accounts to all their corporate clients. Informal trading networks all over Asia now routinely prefer the stability of the RMB to the volatility of the dollar (don't even mention the Euro).

The rebalancing over the weekend probably has as much to do with international trade politics, coming as it has done just days before the G20 meeting in Canada. It is also an important tool for stemming domestic inflation without sharp rate hikes. But in a longer term context, it is another small step in the onward internationalization of China's currency and its corporate outlook.

In its announcement accompanying the news of the rebalancing the People's Bank of China made two explicit statements. Firstly it said that the move was happening because the global economy had stabilized and crisis measures were no longer needed. It also said that its own balance of payments situation was "moving closer to equilibrium," in effect saying that it was importing more and exporting less. By emphasizing both of these issues, China was demonstrating its role as the world's economic locomotive, firstly in stabilizing the world through the crisis and now in getting it back onto a growth path through a rise in domestic consumption.

And yet part of the reason that its economy has been so successful has been the lack of volatility in the currency; companies are very happy to invest overseas if they know there will be no change to the domestic value of their assets. By adopting more of the flexibility that the West seeks, China could undermine that stability. And if there is one thing the Chinese crave more than riches, it is stability.

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