Business

Are Asian currencies undervalued?

by Kanes
The dollar has fallen by about 26 per cent against the euro and by about 11 per cent against the yen between January 20O2 and July 2003. This fall reflects the US’s increasing current account deficit - $ 510 billion in the 12 months ending in March 2003 - caused by the yawning trade deficit - the excess of imports over exports, the result of years of excessive consumer spending. The current account deficit is estimated at 5.3 per cent of GDP in 2003 and is expected to increase further to 5.5 per cent of GDP in 2004.

Western economists believe that the rising US trade deficit and the falling dollar could be arrested to a great extent if the Asian currencies appreciate against the dollar. Although the dollar has fallen by around a quarter against the euro since early 2002, it remains unchanged against the Chinese yuan, the Malaysian ringgit and the Hong Kong dollar - which are pegged to the dollar.

Although other Asian currencies officially float, central banks have been intervening in the foreign exchange markets to hold down their currencies as the dollar has weakened, except in Indonesia. Critics point out that Asia’s currency rigidity is increasing strains on the world economy, particularly as the euro has to rise more than it should pushing it towards dangerously overvalued levels.

At a meeting in Bali in early July, the Europeans urged the Asians to let their currencies rise while the US, IMF and the World Bank called for a stronger yuan. The Group of Seven comprising the US, Japan, U.K., Germany, France, Italy and Canada at its meeting in September appealed to Asian nations to stop trying to keep their currencies weak to make their exports cheaper. They invited China to throw off capital controls and pay greater heed to how its currency and exports affect the world’s trade, growth and jobs. Their communique stated: "We emphasize that more flexibility in exchange rates is desirable for major countries or economic areas to promote smooth and widespread adjustments in the international financial system, based on market mechanisms".

Asia’s external surpluses

The main attack is on China’s Yuan. According to The Economist’s Big Mac Index China has the most undervalued currency in the world, and according to the calculation of the Union Bank of Switzerland (UBS) the yuan is more than 22 per cent undervalued against the dollar. The two criteria used to test whether a currency is undervalued are - first, increasing official reserves and second, rising country’s basic balance (the sum of its current account balance and the net inflows of foreign direct investment). China, Japan, Taiwan and India have had the biggest increases in reserves over the past 18 months and China’s basic balance was 6 per cent of GDP in 2002.

All the Asian countries are having current account surpluses - Japan’s being the largest - and they are some of the world’s countries with the largest official reserves as shown in Table 1. Japan, China, Taiwan, South Korea, Hong Kong, Singapore and India have the largest reserves.

On the basis of these two measures, all Asian currencies, except Indonesia’s are undervalued against the dollar, the most undervalued being China’s yuan, Japan’s yen, Indian rupee and Taiwan and Singapore dollars. The critics further point out that Asia as a whole accounts for half of US trade deficit and US’s biggest trade deficit - $ 103 billion in 2002 - is with China.

The Chinese yuan and the Malaysian ringgit are pegged to the dollar and protected by capital controls while the Hong Kong dollar is tied to the dollar through a currency board. Thus, they remain at the same exchange rate to the dollar. The Indonesian rupiah has risen 27 per cent against the dollar in the past 18 months but others have risen by much less - Japan and South Korea by about 11 per cent, Thailand by 7 per cent, Singapore 6 per cent, India 4 per cent and Taiwan 2 per cent. In the last 12 months however currencies of the Philippines, Taiwan and South Korea have in fact depreciated while others have appreciated as shown in Table 1. (SEE TABLE I)

Asia’s exports

Some blame China for US’s huge trade deficit and for exporting deflationary pressures, but this has no foundation. Imports from China account for less than 2 per cent of GDP in the US and Japan and so they cannot cause deflation. The US trade deficit is not the result of China’s exports but of excessive spending of several years in the consumer boom. The criticism that China and other Asian countries are holding down the currencies to make their exports unduly cheap is based on their low costs of production. For example, China’s textile and garments exports are reported to be 40 per cent cheaper than those of Bangladesh (another low cost producer). China’s products are so competitive that the World Bank estimates that China will control 45 per cent of global textile and clothing exports by 2005. Again, China’s labour costs converted at the country’s low exchange rate are about a quarter of Mexico’s with the result that about 300 manufacturing plants, mainly electrical assembly, have moved from Mexico to China in the past two years. The IMF has also expressed the view that Asia’s rapid growth owes much to undervalued currencies.

Although the US and EU would like Asian currencies to appreciate, the Asian countries are reluctant to do so as it might hurt their exports. Asian economies are heavily dependent on exports which now account for about 64 per cent of the region’s GDP, up from 55 per cent in the early 1990s. They also want to build up their foreign exchange reserves to enable them to face a currency crisis as that of 1996-1997. They do not expect very high growth rates in 20O3 and even 2OO4 - as shown in Table II.

In the case of Japan, a stronger yen would impart a deflationary shock, the last thing Japan needs at present. Thus, their reluctance to appreciate their currencies is understandable. China is worried about its rising unemployment, fragile financial system with heavy bad debts and deflation and consequently it is unlikely to appreciate the yuan or relax capital controls in the near future.

China’s growth rate too is estimated to be lower than in the past - 7.4 per cent in both 2003 and 2004. And as long as the yuan is pegged to the dollar, other Asian countries will also resist appreciation of their currencies. The Chinese Minister of Finance Jin Renqing states: "We take note of the concern about the renminbi (yuan) exchange rate, but the yuan’s stability is conducive to stable economic and financial development not only in China but in the region and the world".

These countries also have highly protected agricultural sectors which will be adversely affected by currency revaluation. In South Korea, for example, locally produced rice is about six times the price of imported Chinese rice and therefore the Korean rice farmer is protected by a 300 per cent import tariff on rice and subsidies. Yet South Korea’s farming community is chronically indebted. A currency revaluation will cheapen imported rice and hit the local farmer harder.

Asia finances the US deficit

The US is unlikely to exert much pressure on China and other Asian countries to appreciate their currencies, as it needs them to finance its external deficit. These countries hold their reserves largely in US government securities and if they become unwilling to invest their reserves in dollar assets, the dollar would fall even faster and the US bond yields would rise. By buying American government securities, the Asian countries are helping to finance the US’s large external deficit, hold down interest rates and thereby sustain the boom in consumer spending and mortgage borrowing. Household savings rate in the US is one of the lowest; it has fallen from 8.7 per cent of disposable household income in 1992 to 3.7 per cent in 2002.

Asia’s investments in the US assets certainly benefit the US in the short- term by enabling households to postpone their post-bubble belt- tightening, but it allows even higher imbalances in the form of consumer debt and current account deficit to continue to build thereby making the eventual adjustment more painful. This, the critics argue is not good for the America and the world economy.

Pressure on China

The Bush administration blames runaway job losses - 93,000 in August alone - on weak Asian currencies in particular the Chinese yuan, and threats have even been made to block imports from China. Failed WTO talks in Cancun are likely to provide extra ammunition for Washington’s politicians in their bid to scapegoat China for US economic woes. With a US presidential race on the horizon, politicians have everything to gain from shifting the blame to China although it risks cooling ties between the two countries. China has meanwhile urged the US not to allow internal politics to interfere with the Sino-US relationship as it weighs up the potentially heavy cost of over reacting to its largest trading partner’s mudslinging.

Although the US conservative politicians say that China is conspiring with the developing countries against US trade interests, the US has clearly benefited from cheap Chinese goods and labour which has provoked many American corporations to set up back offices in China and also, as stated earlier, from Chinese funds to close its external deficit. The former Finance Minister of Japan Eisuke Sakakibara, recently stated: "There are two strategies for countries like the US and Japan: to take advantage of Chinese low costs by building factories and joint ventures there or complain and gripe to try and force a currency revaluation. I think the former is the right one". More importantly, the US needs Chinese cooperation in solving the North Korean nuclear crisis and fighting world terrorism, the backbone of Bush presidential policy deflation and consequently it is unlikely to appreciate the yuan or relax capital controls in the near future.

China’s growth rate too is estimated to be lower than in the past - 7.4 per cent in both 2003 and 2004. And as long as the yuan is pegged to the dollar, other Asian countries will also resist appreciation of their currencies. The Chinese Minister of Finance Jin Renqing states: "We take note of the concern about the renminbi (yuan) exchange rate, but the yuan’s stability is conducive to stable economic and financial development not only in China but in the region and the world".

These countries also have highly protected agricultural sectors which will be adversely affected by currency revaluation. In South Korea, for example, locally produced rice is about six times the price of imported Chinese rice and therefore the Korean rice farmer is protected by a 300 per cent import tariff on rice and subsidies. Yet South Korea’s farming community is chronically indebted. A currency revaluation will cheapen imported rice and hit the local farmer harder.

Asia finances the US deficit

The US is unlikely to exert much pressure on China and other Asian countries to appreciate their currencies, as it needs them to finance its external deficit. These countries hold their reserves largely in US government securities and if they become unwilling to invest their reserves in dollar assets, the dollar would fall even faster and the US bond yields would rise. By buying American government securities, the Asian countries are helping to finance the US’s large external deficit, hold down interest rates and thereby sustain the boom in consumer spending and mortgage borrowing. Household savings rate in the US is one of the lowest; it has fallen from 8.7 per cent of disposable household income in 1992 to 3.7 per cent in 2002.

Asia’s investments in the US assets certainly benefit the US in the short- term by enabling households to postpone their post-bubble belt- tightening, but it allows even higher imbalances in the form of consumer debt and current account deficit to continue to build thereby making the eventual adjustment more painful. This, the critics argue is not good for the America and the world economy.

Pressure on China

The Bush administration blames runaway job losses - 93,000 in August alone - on weak Asian currencies in particular the Chinese yuan, and threats have even been made to block imports from China. Failed WTO talks in Cancun are likely to provide extra ammunition for Washington’s politicians in their bid to scapegoat China for US economic woes. With a US presidential race on the horizon, politicians have everything to gain from shifting the blame to China although it risks cooling ties between the two countries. China has meanwhile urged the US not to allow internal politics to interfere with the Sino-US relationship as it weighs up the potentially heavy cost of over reacting to its largest trading partner’s mudslinging.

Although the US conservative politicians say that China is conspiring with the developing countries against US trade interests, the US has clearly benefited from cheap Chinese goods and labour which has provoked many American corporations to set up back offices in China and also, as stated earlier, from Chinese funds to close its external deficit. The former Finance Minister of Japan Eisuke Sakakibara, recently stated: "There are two strategies for countries like the US and Japan: to take advantage of Chinese low costs by building factories and joint ventures there or complain and gripe to try and force a currency revaluation. I think the former is the right one". More importantly, the US needs Chinese cooperation in solving the North Korean nuclear crisis and fighting world terrorism, the backbone of Bush presidential policy.


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