Rise of the RMB

Prasad on Mitt’s “tough” talk

If elected would Romney label China a currency manipulator?

Prasad on Mitt’s “tough” talk

“Romney is trying to prove he’s tough,” says Eswar Prasad

Mitt Romney likes to stir up the crowds with his aggressive views on the Chinese currency. On day one of his presidency he vows he’ll label China a currency manipulator. If Romney makes it to the Oval Office will he go through with this threat and risk a trade war? Hard to be sure. After all we’re dealing with a candidate who knows more about flip-flops than a Spanish beach attendant.

One expert who thinks it unlikely is Eswar Prasad, the Tolani Senior Professor of Trade Policy at Cornell University (he’s also a Senior Fellow at the Brookings Institution). Previously, Prasad worked for the International Monetary Fund, including a spell as head of the IMF’s China Division. Last week he was in Hong Kong and shared his views with WiC.

So the latest US Treasury report avoided calling China a currency manipulator once again…

China has never been labelled a currency manipulator. It’s a serious charge that would trigger an evaluation process at the IMF, as well as a series of potential responses. There would also be significant political repercussions.

Remember that this reporting process was set up years ago, and more with Japan in mind amid concerns about the yen. At that time China didn’t even feature as it wasn’t a major trading partner. But now it is the one country that everybody focuses on when the report comes out.

In fact only two consultations – one for Sweden and one for South Korea – have been launched by the IMF after a charge of currency manipulation. And in both cases the conclusion was that neither was manipulating its currency.

Is it getting tougher to make the case that the renminbi is undervalued?

Yes, last month’s report recognised that a lot has changed over the last five years. China’s trade surpluses have shrunk (although the bilateral surplus with the United States remains high). The renminbi has appreciated almost 40% in inflation-adjusted terms against the dollar since mid-2005. This makes it harder to argue that the Chinese currency is undervalued, even though the latest Treasury report says that it expects the renminbi to appreciate further in future.

But Mitt Romney says he would confront China on its currency on his first day in office?

Romney is trying to prove he’s tough. Saying that he will stand up to China plays well in the electoral heartlands. Given that much of the debate about the renminbi is framed in terms of job creation, it could become more of an issue in presidential campaigning if the unemployment rate stays above 8%. Then there is more likelihood that China will be made a scapegoat.

Which US businesses are demanding a stronger renminbi?

There are two main groups with an interest. Companies in direct trade competition with China – some of the tyre manufacturers, for example – have been frustrated with Washington’s stance on currency policy for a while. Then there is a bigger constituency that is looking for market access to China, including the larger multinationals and financial services groups. Previously they haven’t wanted to push too hard for action if it means jeopardising their chances of better market access. But they haven’t been making the progress here that they would like, so some are calling for a tougher line on the currency as a result.

But it’s not a straightforward issue. There can be multiple views within a single company. General Electric is a good example. At one level it is in direct competition with China, so it isn’t pleased about a weaker currency. But another part of GE is trying to get market entry and wants a more amicable relationship. And then there is a third interest group at GE running manufacturing operations in China. So you have differing viewpoints on the renminbi within a single organisation.

Why don’t the Europeans make the same noise on the renminbi as the Americans?

Well, it’s true that the renminbi has been increasing in value more slowly against the euro than against the dollar, by about 25-30% in inflation-adjusted terms over the last seven years.

But the key issue is that Germany wants to maintain good relations with China because it exports so much there. And if you don’t have Germany leading the charge, it isn’t obvious how you can get the EU to take a tougher stance collectively.

Sure, the Europeans talk among themselves constantly about the currency issue, and the Americans want them to speak up more. But they haven’t acted in a coordinated way.

Are there differing views in China on what to do with the renminbi?

Yes. In general terms the People’s Bank of China, the State Administration of Foreign Exchange and the China Banking Regulatory Commission are all keener on a more flexible exchange rate. They see this occurring naturally as part of the process of opening up the capital account and achieving financial reforms.

The Ministry of Commerce, which represents the interests of exporters, is more cautious about a stronger currency.

That often means that the key player in the debate is the National Development Reform Commission. The way that it votes can tilt the balance towards one side or the other, determining which of the factions has the upper hand.

What’s your view on the progress of renminbi internationalisation?

The Chinese approach has been consistent with reforms undertaken in other areas: test things out on a smaller scale, ‘learn by doing’, and then roll out the programme on a wider basis.

Hong Kong has also proved to be an excellent testing ground for areas like trade settlement, the accumulation of yuan deposits offshore, and the issuance of renminbi-denominated bonds.

The trade settlement situation is interesting. About 8-9% of Chinese trade is now paid for in renminbi, which is an impressive volume after just three years of reforms.

But on closer inspection, virtually all the settlement is for payments to foreign exporters made by Chinese customers. The volume of invoicing in renminbi in the other direction – by Chinese exporters to foreign buyers – is minimal. The preference on both sides seems to be to hold renminbi whenever possible, which means that the settlement flows currently look lop-sided. It’s an area to watch as it’s unclear how it might reflect on the renminbi’s potential to become an international currency.

Opening up the capital account further also requires a delicate balancing act, especially as it becomes harder to limit exchange rate fluctuations once capital starts to flow aggressively cross-border.

But another important point is that giving China’s households and corporations more options to invest abroad should also stimulate reforms of the domestic banking sector, where policymakers have been disappointed at the lack of progress.

We saw some of that frustration in Wen Jiabao’s comments about monopoly profits in the banking sector in April. In my view the internationalisation of China’s currency has domestic goals too. It’s what I have identified as a kind of Trojan Horse strategy: the push to promote the renminbi overseas has the collateral benefit of overcoming vested interests at home.

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