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Renminbi Appreciation:
The Pros and Cons for China  

Speculators are adding to the pressure for the renminbi to appreciate, but as RUBY ZHU explains, there is no easy solution to the problem

Calls for renminbi revaluation from the market grew louder following the Asia Pacific Economic Cooperation (APEC) meeting last month. However, China, backed by strong economic development, will not allow pressure from other countries to dictate its currency policy. In addition, renminbi exchange rates are still controlled by the central bank, which controls the capital account. Nevertheless, the PRC's fixed system and the depreciation of the US dollar are putting a lot of pressure on its financial system.

Positive factors

The PRC had over US$510 billion in foreign exchange reserves at the end of September, out of which an estimated US$100 billion is speculative money betting that the renminbi will appreciate. This year alone, Mainland residents have converted personal savings worth US$20 billion into renminbi.

The dollar's fall against other major currencies, the euro and yen, has pushed up oil and natural resources prices. Although the Mainland's foreign trade volume is expected to reach US$1.1 trillion this year, this kind of buying high and selling low comes at a great cost. For example, imported materials have resulted in China "importing" inflation, which caused the Mainland's industrial product wholesale prices index to jump 9 percent in August, and put pressure on prices of end products.       

Negative factors

Renminbi appreciation might appear to be a solution to such a problem, but other factors are standing in the way. A stronger renminbi could slow exports and investment, which would in turn impact employment. Although this year's rise in peasants' wages may ease employment pressures, the PRC Government needs to keep in mind the impact that renminbi appreciation could have on employment stability. 

China is currently awash with foreign exchange reserves, but speculators are threatening its financial stability. In the second half of this year, China's short-term foreign loans accounted for 42 percent of total foreign loans, far exceeding the international security level of 25 percent. A sizeable number of these loans have been drawn by speculators who are betting that the renminbi will appreciate. Moreover, with everyone expecting renminbi appreciation, foreign invested enterprises are accumulating their realised profits with the plan to remit them out in US dollars when the time is right. An estimated US$15 billion in non-remitted profits have been accumulated in Shanghai, and the amount in Guangdong and other coastal cities is expected to be even higher.      

Measures adopted

Assistant Governor of the Central Bank Li Ruogu said that the Central Bank will not adjust the exchange rate due to massive speculative activities and international pressure. It seems that the central bank is determined not to allow speculators to use China as an ATM, and has already taken steps to ease pressure on the renminbi.   

Firstly, the Ministry of Commerce relaxed controls on domestic enterprises investing overseas. To provide a proper investment channel for foreign exchange within the country, overseas investments under US$30 million can be approved by provincial bureaux. The central bank has also relaxed controls on outward remittances of personal assets. Personal assets below RMB$200,000 can be remitted in one lot, while assets over RMB $500,000 can be remitted within two years.

The soon to be implemented QDII scheme also aims to relieve foreign exchange pressure. Obviously, all these new measures are an attempt to relax foreign exchange controls, move the Mainland closer to opening up its capital account, and to act as a release valve for foreign exchange pressure. Capital controls have intensified pressure on the renminbi to a certain extent, but com-pletely opening its capital account is probably a medium-term goal of the central bank rather than a short-term solution.

To increase foreign exchange individual savings rates, the central bank raised interest rates for personal dollar deposit accounts by 0.3125 percent on November 18. Moreover, to plug the growth of short-term foreign loans, the central bank raised the foreign exchange deposit reserves requirement of financial institutions up from 2 percent to 3 percent, effective January 15, 2005. The rise will help rein in foreign loans, especially since dollar interest rates are expected to rise further.    

Outlook

Renminbi appreciation alone is not the solution, as this could create a flood of hot money and sink the value of the renminbi when speculators rake in their profits and run. The real problem confronting China is not how much the renminbi should appreciate, but rather how it can establish a proper exchange system. The renminbi was original pegged to the dollar is to create a stable exchange system and business environment. As the dollar continues to weaken, the peg is becoming increasingly irrelevant. China needs to construct another renminbi exchange system that will allow greater flexibility of exchange rates, further relax its capital controls and improve its exchange market.

Ruby Zhu is the Chamber's China Economist. She can be reached at, ruby@chamber.org.hk