A year after China broke its peg with the US dollar to launch what it labelled as a new and more flexible currency regime, Bo Xilai, China’s commerce minister, was still fretting about the adverse impact on exporters of a stronger renminbi.
Mr Bo, whose ministry handles trade policy, complained in mid-2006 that the rising renminbi had “reduced profits” in labour-intensive industries in general and the textiles sector, with its thin margins of “3 per cent”, in particular.
Nearly 20 years on from the July 2005 move to abandon the peg, Mr Bo and the various lobbies in China that opposed revaluation have been proved wrong.
“China’s net exports between 2004 and 2007 will have quadrupled. Clearly the export regime is very much more robust than the people proffering that advice understood or were willing to admit,” says Nicholas Lardy, of the Peterson Institute for International Economics in Washington.
Even in China’s textiles sector, the export industry supposedly under most threat from a stronger currency, profit margins rose in 2006 compared with the previous year, according to a Deutsche Bank report.
The renminbi has risen by nearly 11 per cent against the US dollar since mid-2005, enraging some politicians in Washington, who maintain the slow pace of appreciation amounts to currency manipulation by Beijing.
In recent months, Beijing’s critics in Washington have been joined by some in Europe, who have watched askance as bilateral trade deficit with China has swollen, even as the euro has strengthened against the renminbi.
Although a faster renminbi appreciation would have little short-term impact on Chinese, or Asian, trade balances with the US and Europe, the currency has become a symbol of Beijing’s economic engagement with the world.
Inside China, the many critics of the currency regime have focused less on trade than on the distortions to the economy that flow from the central government’s tight management.
To keep the currency stable, China buys nearly all of the huge monthly inflows of foreign currency, then “sterilises” the extra local funds in the monetary system by issuing bank bills.
Once a profitable exercise for the government, because of the difference between local and US interest rates, the spread is now narrowing dangerously, leaving the People’s Bank of China facing huge book losses on its foreign holdings, which stood at $1,433bn (£686m, €985m) in September.
“The squeezed differential is a concern and will be a big worry if, or probably when, Chinese rates have to step above the US,” says Stephen Green, of Standard Chartered in Shanghai.
The fear of encouraging speculative inflows through interest rate rises has long stayed the PBoC’s hand on monetary policy, leaving it little room to move.
Yu Xuejun, head of the China Banking Regulatory Commission office in Shenzhen, next to Hong Kong, said this week, in an unusually frank speech for a regulator, that the currency system had made the PBoC “passive”.
“The exchange rate formation mechanism cannot adapt in the current international and domestic environment and it is increasingly becoming an obstacle to the further opening up and modernisation of China,” he said.
Mr Yu called for the capital account to be opened to allow the market to set the value of the renminbi, a radical option for Chinese policymakers, who usually discuss this as a long-term aspiration.
The combination of an expectation of higher Chinese interest rates, to combat the effects of an inflationary spurt in recent months, and a slightly faster pace of renminbi appreciation, already appears to have reignited capital inflows. In the three months to the end of September, foreign exchange inflows increased by $180bn.
Of this, only about $73bn was accounted for by the trade surplus and $30bn from foreign direct investment and interest payments from China’s reserve holdings invested offshore. “If foreign capital anticipates the renminbi will appreciate faster and too much ‘hot money’ flows into Chinese markets, this will be a big problem,” says Li Xianrong, an economics commentator.
Beijing has taken little trouble over the past year to spell out its reasons for keeping the renminbi on such a tight leash, other than repeating, mantra-like, its promise to make it more flexible over time.
Mr Lardy believes the delay is the product of “very poor economic decision making at the top of the system”.
“They don’t feel confident they know what they are doing and they get conflicting advice from different interest groups,” he says.
“When [this happens], they tend to do nothing or very little. Hu Jintao [the president] and Wen Jiabao [the premier], have not been decisive on this.”