Chinese Central Bank Steps In Strongly To Control Its Overheating Economy-VRK100-13012010

CHINESE CENTRAL BANK STEPS IN STRONGLY TO CONTROL ITS OVERHEATING ECONOMY.


What will Reserve Bank of India do now? When is the CRR hike likely in India?

Rama Krishna Vadlamudi

January 13, 2010

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CHINA RAISES ITS RESERVE RATIO BY 50 BASIS POINTS:

Chinese Central Bank on January 12th raised the reserve requirement ratio, the proportion of deposits banks must set aside as reserves, by 50 basis points with effect from January 18th. The present hike my drain out liquidity in China to an extent of 200-300 billion yuan. It was the first time revision in the ratio since it lowered the ratio in December 2008.

Apparently, People’s Bank of China is raising the ratio in order to cool its overheating economy and to control inflationary pressures. The raise is likely to arrest any asset bubbles in the Chinese economy. The move came earlier than anticipated by the markets.

Interestingly, the hike in reserve ratio has come after reports suggested over-lending by banks in China in the last six months or so. In the first week of this year alone, loans have gone up by 600 billion yuan. A few days back, China has surpassed Germany as world’s largest exporter. China’s exports rose around 18 per cent in December 2009. Total exports of China in 2009 were USD 1.2 trillion, down 16 per cent over 2008. Total imports in 2009 were at USD 1.01 trillion, down 11 per cent over 2008. Even though German data for 2009 is yet to be out, it is expected that China has overtaken Germany in exports. Moreover, China is expected to overtake Japan as the world’s largest economy this year. All this point out to a dominant China going forward.


EXIT STRATEGY OF CENTRAL BANKS AND WHAT WILL RBI DO NOW?
 

China has become the second country, after Australia, to chalk out its exit strategy from loose monetary and fiscal policies, which were pursued to stimulate its economy which was reeling under severe downturn following the global financial meltdown in 2008. The surprising move by Chinese Central Bank is likely to influence the decisions of Reserve Bank of India when it meets on January 29th for the third quarter review of its Annual Policy. In all likelihood, RBI may raise CRR by 50 basis points in order to curb the spiraling food inflation even though some policymakers want to continue the loose monetary policy for some more time.


WHY ARE INDIAN EXPORTERS LOSING OUT COMPARED TO CHINESE EXPORTERS?

India’s currency has appreciated against the US dollar of late. It has gone up from around 52-level to the present 45.70-level. During the first week of March 2009, Rupee touched a high of 52 against the US dollar. At that time, Chinese Renminbi was hovering around 6.845 versus the dollar. And now it is quoting at around 6.827, signifying its stagnated level. While Indian Rupee appreciated by about 12.12 per cent against the USD in the last 10 months, the Chinese currency’s appreciation was negligible at 0.26 per cent. The lack of appreciation of Chinese currency is beneficial to Chinese exporters, whereas rupee’s 12-per cent appreciation has acted as a dampener for Indian exporters. Comparatively, other Asian currencies, except China, too have shown appreciation against the US dollar.

The question that has been exercising the minds of several developed countries is China’s continued reluctance to allow any appreciation of Yuan. At present, Chinese currency Yuan or Renminbi is grossly undervalued. A recent Reuters’ poll has suggested that Yuan is undervalued by about 20 per cent. China has amassed huge foreign reserves (USD 2.2 trillion). These huge reserves have been built up with large export surpluses over many years by keeping its currency undervalued. Many trading partners, governments and economists in the Western world have been highly critical of China’s stonewalling tactics. But the criticism is not new to the Chinese government. The US has been putting pressure on China since 2002 to allow Yuan appreciation. In July 2005, China removed pegging its currency to the dollar and moved to a managed floating rate regime based on market supply and demand. At that time, the Yuan was quoting at 8.30 to a dollar. This means the Yuan has appreciated against the USD by 17.7 per cent in four and a half years.

In fact, China had continued with its gradual appreciation till the collapse of Lehman Brothers in the middle of September 2008. Afterwards, China has not allowed any appreciation of its domestic currency to protect its exports. (On September 15th, 2008, Yuan was quoting at 6.85 to a US dollar). China is a global manufacturing factory and is heavily dependent on its exports. Any adverse impact on its exports will undermine its labour markets. China has to protect its domestic economy from the ill-effects of the global financial meltdown. China’s first priority is to protect the jobs of its domestic workers, while creating more jobs for them. So, it has been playing very hard with its currency by not allowing any appreciation against the US dollar. However, this has earned the wrath of many of its trading partners. China’s export juggernaut continues to roll for the time being. And China is not in a hurry to give in to any outside pressures and will pursue its own exchange rate policy. China has become a superpower of sorts in its own right and it has been flexing its muscles unabashedly. China usually does not tolerate any interference from outside world.

How long will China continue with its policy of undervalued domestic currency? There are no easy answers. That is the million-dollar, sorry, billion-yuan question in the minds of market players around the world.