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Monday, September 22, 2003

Why This is not a Good Time to Revalue Renminbi

Following up on the China financial reform topic, here's Andy Xie from last Friday:

I believe China must reform its financial system before it can open its capital account and change its currency policy. The reforms are not just about solving the stock of non-performing loans in the banking system, but more importantly, they are also about stopping the banking system from accumulating more bad loans.

The non-bank financial sector also presents a serious risk to China’s stability, in my view. In particular, our strategist believes the stock market is overvalued; I believe it is not a level playing field.

Further, the inefficient financial system reflects the contradiction between the need to narrow the gaps in regional incomes within China and the inability of the government to collect taxes. If China does not streamline its tax system to raise national tax revenue to more than 25% of GDP, the central government will likely have to continue to rely on banks to support investment programs in poor provinces to narrow the gaps in regional incomes.

There is a race between GDP and bad debt in China. If the latter grows faster, as it has been in the past, China may need to devalue the currency when its exports slow down because inflation is needed to reduce the burden from bad debt. Although productivity gains may support a renminbi appreciation at some point, the financial system is distinctly pointing at the other direction. If you are betting on the renminbi today, I say good luck.
Source: Morgan Stanley Global Economic Forum

And don't miss this part:

For each US$1 in value for a product that China exports to the US, a product sells for US$4–5 at the retail level in the US. Therefore, American brand owners and distributors benefit far more from China’s output than the Chinese themselves. Moreover, for each US$1 in value for a product that China exports to the US, businesses in Hong Kong or Taiwan take 20 cents.

and remember, a lot of Chinese exports to the US are of products which originate in Hong Kong or Taiwan, and which have simply been 'processed' (assembled etc) in China. A revaluation of the Chinese currency would have no impact on the underlying value of the core components. So it is not clear that anything other than a sharp correction would have more than a negligible impact on the US trade deficit with China, and a sharp revaluation would surely be deflationary and destabilising (which would also amount to the same thing) inside China.

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