Mon, Apr 24, 2006 page8

• Editorial: Yuan diplomacy has a long way to go

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  The four-day visit to the US by Chinese President Hu Jintao (胡錦濤) to the US ended last Friday, and left many disappointed. Most economic commentators in the US were looking for an indication that the yuan exchange rate mechanism would be further liberalized, or that some measure of revaluation would occur. However, the meeting between Hu and US President George W. Bush yielded nothing.

  It may be too early to say how people will judge last week's summit, particularly as a diplomatic or strategic event. But on the currency front, disappointed currency traders have already made their judgment. On Friday, markets in Shanghai pushed the yuan lower against its US counterpart, with the Chinese currency dropping 0.06 percent to close at 8.017 yuan to the dollar.

  All we learned during about the Chinese leader's stance on the yuan issue was his tedious remark that "China will continue to move toward a flexible but stable exchange rate regime." Hu's comment lacked any specific details or timeframe. The currency issue did not even rate a mention during Hu's speech to US business leaders soon after his meeting with Bush.

  Bush failed to obtain a commitment from Hu on how to further increase the flexibility of the Chinese currency. Despite last year's reforms, the yuan remains pegged to the US dollar. Rightly or wrongly, this has become a touchstone in debates about the huge US trade deficit with China, which widened to a record US$201.6 billion last year. This was particularly annoying for the Bush team, which has branded China a currency manipulator. The IMF has also warned that the large US trade deficit will eventually scare away investors and could presage a downturn in the global economy.

  Meanwhile, finance ministers and central bankers from the G7 industrialized countries have begun to lose patience with the issue. The group stated on Friday that China should revalue the yuan, something the group has never said before. In the past the G7 has restricted its comments to suggesting more flexibility in the yuan exchange rate regime, without saying whether the Chinese currency should strengthen or weaken. Although China revalued its currency by 2.1 percent against the US dollar last July, and has repeatedly pledged to advance the reform of its exchange rate regime, its efforts on both counts have been too slow to satisfy the country's trading partners.

  China's GDP grew by 10.2 percent in the first quarter of this year, and the pressure on the yuan to appreciate is certain to increase. To slow gains in the yuan, China's central bank has to buy US dollars and sell its own currency, which fuels inflationary fears and increases the country's foreign exchange reserves to unsustainable levels. At US$875.1 billion at the end of last month, China already has the world's largest stockpile. An increase in domestic interest rates is overdue and what better way to do this than through a revaluation of the yuan?

  A yuan major revaluation would have important ramifications for Taiwan. On one hand, the New Taiwan dollar will be subject to strong pressure to appreciate. On the other hand, a stronger yuan might force Taiwanese manufacturers based in China, particularly those focused on exports, to relocate to cheaper production sites in Asia. However, those Taiwanese manufacturers who concentrate on China's domestic market would benefit from a stronger yuan as it will allow Chinese consumers to spend more.

  Nevertheless, it is hard to predict what Beijing's next move will be regarding its currency. What's certain, however, is that the yuan will continue to move up gradually and the value of NT dollar will rise with it.
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