Rx for China's fevered economy: Revalue
the yuan By Macabe Keliher and Tung
Chen-yuan
HONG KONG - Chinese Premier Wen Jiabao
has a big task: to clean up the mess of a domestic
economy the country has built. Yes, his predecessor did
a fine job of encouraging growth, but dear old Zhu
Rongji also let non-performing loans run rampant, and
imbued what seems like the entire Chinese population
with the idea that a currency peg must act as the
foundation for China's economy.
Premier Wen now
has the historic opportunity not only to correct his
country's structural economic problems, but also to also
stand alongside 19th-century Chinese trade commissioner
Robert Hart and completely integrate China into the
global economy. The premier needs to revalue the yuan
and adjust the exchange-rate regime.
By all
appearances, Wen is up to the task. Last week he told
Reuters of the "need to take effective and very forceful
measures to resolve those problems" - namely, inflation,
non-performing loans, excessive money supply, and
overinvestment in certain sectors. He has already
ordered or overseen a clampdown on bank loans and put a
stop to the construction of at least one steel mill.
Heck, he has even said officials are studying the
possibility of a currency revaluation.
Wen has
no other foreseeable viable option to deal with the host
of economic problems the country now faces than allowing
the yuan to appreciate. Only when this happens, and
China's currency floats freely on the market just like
other major currencies of major economies, can the
country's structural deficiencies be untangled.
Structural problems In mid-April, the
National Bureau of Statistics (NBS) put out the economic
figures for the first quarter of 2004 in a seven-point
press release on how "the overall situation of the
national economy has been good in this year": economic
growth at 9.7 percent, agriculture grew at 4.5 percent,
industry and manufacturing at 11.6 percent, and services
at 7.7 percent; fixed-asset investment growth was up by
a whopping 43 percent; consumer inflation up by 2.8
percent, of which food prices rose by more than 7
percent; and foreign investment continued to flood in at
an almost 50 percent increase over the same period last
year.
Such figures might signal a good year if
it were still the 1990s and certain sectors in the
economy were not nurturing a ballooning bubble. The NBS
thinks so too, and thus gives a vertical garbage list,
at the end of the press release, of the "major problems
during economic operations": "The fixed investment grows
too fast, the blind investment and low-level duplicate
construction in some industries and regions have not
been checked effectively, which results in the
aggravation of bottlenecks, such as major raw materials,
energy and transport, and which results in constant
price rise."
Fixed investment, or investments in
fixed assets such as real estate or factories, grew by
more than 40 percent in the first quarter year-on-year.
This is the fastest growth in China's modern history -
almost three times the 25-year average of 15 percent.
What this means is that investors are shoveling money
into real estate, which is jacking up prices and
creating an artificial bubble just waiting to pop -
figures from the end of 2003 estimate that real-estate
vacancies stand at 26 percent, quadruple the US figure,
eight times Hong Kong's and two and a half times the
international norm.
In industries supporting
real-estate construction, such as steel, cement and
building supplies, fixed investment is as high as 172
percent (iron and steel). Official government estimates
say that when all steel projects currently under
construction come to full production, they will turn out
more steel in 2005 than the country will be able to use
until 2010.
With such threatening
overinvestment, the People's Bank of China warned that
it "could inflame inflation or asset price bubble,
resulting in new non-performing loans and financial
risks", those financial risks being mass bankruptcy as
the result of market oversupply.
Much of this
excessive investment is going into blind investment and
duplicate construction, which pose the same risks. Blind
investment finds banks and independent investors
throwing money at some project or industry without any
risk assessment, or just following the lemmings into a
booming, but potentially disastrous, industry.
Likewise, duplicate construction means jumping
on some bandwagon and overinvesting in an industry that
is already overinvested. For example, the Zhujiang area
in Guangdong has eight airports in a region the size of
Massachusetts and Connecticut. In addition, local
governments fall all over each other to establish
special economic zones, but 43 percent of the land in
such zones remains unused.
Stopgap
measures Some of these problems may sound
non-structural. Just curb lending and rein in bad and
redundant investments and everything's fine, right?
That's what Zhu Rongji thought in 1993, and he ended up
with a recession, deflation and insolvent banks.
Unfortunately, authorities today are trying to
do the same thing. The central bank raised the reserve
requirement for banks by half a percentage point to 7.5
percent, and has called for banks, enterprises and local
governments to help curb investments and cool down the
economy. The China Banking Regulatory Commission said
last week that banks should stop lending to steel,
aluminum, cement, real-estate and automobile industries.
And over the weekend Vice Premier Huang Ju said that government
will suspend projects in these areas, and tighten
approval for new projects.
The problem is, the
situation is different from that of the early 1990s.
Foremost, the market mechanism has become the driving
force in the Chinese economy; but even more so, the rate
of investment is incomparably greater today than it was
then because of hot money.
Hot
money Hot money is outside investment looking for
a quick profit. It is liquid, short-term, and invests in
overheated sectors to harvest the largest gains. For
instance, profits on investments in the steel industry
increased by more than 100 percent year over year in the
first two months of 2004.
By calculating China's
trade revenue against its total foreign reserves, we can
estimate that the amount of hot money flowing into the
country in the first quarter this year may amount to as
much as US$30.9 billion, for an increase of 25.6 percent
over last year, which is no small feat considering that
China's foreign reserves increased by 57 percent last
year.
Because China keeps the yuan pegged to the
US dollar on about a 0.3 percent band, the central bank
must sell yuan and buy greenbacks, which, given the
increasing foreign currency coming into the country,
will create more money supply. In 2003, for example, the
base money supply in China increased by 748.4 billion
yuan ($90.52 billion), of which 685 billion yuan, or
91.5 percent, came from an increase in official
foreign-exchange reserves.
Furthermore, the
central bank needs to sterilize foreign-exchange
reserves by selling treasury bonds, and to sell more
treasury bonds it will have to raise interest rates,
which only encourages more hot money as speculators
change their dollars to yuan in anticipation of a
revaluation. There investors wait, collecting higher
interest rates until they can sell back their yuan at
costs below what they paid. Meanwhile, China's economy
continues to boil with overinvestment, and inflation in
underinvested sectors steams with the excess money on
the market.
Revalue the
yuan Administratively, the government has done
all it can do and the economy is still overheating. The
loan curb, the halt to projects, the reserve
requirement, will not, unfortunately, "take off in the
future", as Premier Wen said. With such measures he will
see the feared "major ups and downs in our economic
development". The government now needs to revalue the
yuan and devise a new exchange-rate regime.
A
10-15 percent revaluation of the yuan would take
speculative pressures off the currency immediately, and
foreign money coming into the country to invest in
overheated industries would slow overnight because
investors would be getting fewer yuan for their dollar.
At the same time, such a revaluation would restore
policymakers' flexibility in managing both fiscal and
monetary policy, eg enable them to raise interest rates
without consequences.
In addition, the yuan
should be completely removed from its peg to the US
dollar and repegged to a currency basket weighted on the
currencies of China's major trading partners. This would
maintain the equilibrium value of the yuan in a dynamic
global economy. Once it is repegged, and a new reference
basket implemented, any additional moves, such as
widening the trading band, could be phased in during a
transition period of some years. This would provide a
safe and effective path to a more flexible-exchange rate
regime.
Of course, playing with the currency
does come with many risks, as Beijing and Chinese
commentators have continued to imply so vigorously. But
the risks of maintaining a status quo are far greater.
Macabe Keliher is an independent
historian and journalist, and a regular contributor to
Asia Times Online. His website iswww.macabe.net. Tung
Chen-yuan is assistant research fellow at the
Institute of International Relations of National
Chengchi University in Taiwan. He can be reached atCTung@jhu.edu.
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