Saturday March 20, 2010

Currency trends

By CECILIA KOK

cecilia_kok@thestar.com.my

Trade war looms over differences between US and China’s perception of their currency values.

SINCE the opening up of its economy three decades ago, China has been prospering and powering ahead with enviable high growth rates over the last 10 to 15 years. Providing a low-cost environment, many manufacturing companies sprouted across the country, producing a wide range of goods (from toys and textile to electrical and electronics) to satisfy the demand of global consumers. With that, China has earned the tag of the “factory of the world”.

From an impoverished nation to a socialist market economy, the miracle of China’s growth is mainly attributable to its thriving exports. The growing global demand for China’s produce has been pinned on the fact that the prices of its goods are found to be much more cheaper than those produced in other countries.

For some countries, particularly developed nations such as the United States, however, there’s been a negative effect. With cheap China goods flooding the market, these developed nations claim that many of their local manufacturers have been put out of business because they could not produce goods to match the prices of China goods.

On the Chinese side, the government continues to intervene in the financial markets, in particular over the pegging of the exchange rate of the yuan against the US dollar, to keep the prices of its goods competitive in the global market and as a means to further promote its exports and attract foreign direct investments.

While the strategy has worked well in its favour, China has over the years faced continuous pressure from developed nations, particularly the United States, to allow its currency to appreciate.

The yuan was pegged at 8.27 per US dollar from 1995 to mid-2005. The Chinese government subsequently adjusted the value of its yuan upwards to 8.11 per US dollar and lifted the peg and allowed its exchange rate to fluctuate against a basket of currencies, including the US dollar, euro and yen.

In July 2008, the Chinese government allowed a 21% appreciation of its currency against the US dollar and the value of yuan has since been pegged at around 6.83 per US dollar to this day.

Many economists from developed countries claim that the yuan is currently still undervalued by a wide margin of between 20% and 40%. Hence, the rising pressure from the international community, particularly over the week, on China to let its currency appreciate.

For instance, the International Monetary Fund (IMF) and the World Bank on Wednesday lent their support to the United States to urge China to allow its yuan to float.

Addressing the European parliament, IMF managing director Dominique Strauss-Kahn said “this cannot be avoided; in some cases exchange rates have to appreciate, and that’s the debate which is very well-known about China and the value of the yuan”.

The Chinese government manages to keep its yuan at the pegged rate by buying US dollar. The US government calls this currency manipulation, and will decide by next month whether to declare China as a currency manipulator. The sentence will be stiffer tariffs for all China goods to compensate for the unfair advantage that the dragon economy has been enjoying all these years.

While stating its reluctance to adjust the value of its currency, China has called such pressure on it to comply as a trade protectionism measure on the part of the US government. The Chinese government has indicated that it would respond with the same sort of import tariffs on US products should its export goods be levied with tariffs by the US government.

Economists see such development as a rising risk of trade war between the two major economies, which could be destabilising for global economy.

“With two giants fighting, there will surely be some spillover effects on the other economies in the world,” RAM Holdings Bhd chief economist Dr Yeah Kim Leng says.

There is certainly room for accommodation, especially on the China’s side to allow its currency to appreciate. But economists point to China’s main concern on the impact of the yuan appreciation on its industries, which are mainly export-driven. In other words, many factories, particularly those that are labour-intensive and have low profit margin, could possibly close down if global demand for their goods fall, as a higher yuan could render their goods less competitive in the global market.

While Western economists say the appreciation of the yuan is the most effective way to address the global trade imbalances, some Asian economists contend that currency alone cannot help fix the situation.

Put house in order

“Developed nations have to put their house in order first, and not just depend on Asia to adjust their currencies,” CIMB Research chief economist Lee Heng Guie explains, pointing to the low savings rates as one of the key issues that developed nations has to address.

Nevertheless, many believe that there will be a gradual appreciation of the Chinese currency. Some quarters say the appreciation of the yuan would likely start towards the second half of this year, as its domestic economy continues to strengthen amid the country’s rising inflationary pressure.

“There are benefits and economic justification for China to allow its currency to appreciate,” Yeah says.

These include the need to control inflation and prevent the overheating of its rapidly growing economy as well as to increase its purchasing power to import more goods and services and to acquire foreign assets, Yeah explains.

Regional currencies, including the ringgit, will likely track how China can accommodate to the pressure on its currency to appreciate in the days ahead.

“Certainly, any movement of the yuan, which is the anchor currency of the region, will affect the movement of regional currencies, including the ringgit,” Lee says.

Over the past one year, the ringgit has been strengthening against the US dollar. Year to date, it has gained about 3.5% against the greenback to trade at around RM3.30 per US dollar.

As it stands, there are some contrasting views over the performance of the ringgit towards the end of the year. While many believe the Malaysian currency will strengthen as a reflection of its strengthening economic fundamentals (or as it tracks the trend of the possible rise in yuan), a local bank analyst sees the possibility of a weaker ringgit by the end of the year.

He reasons that the strength of the US dollar would likely return by the second half of the year on expectations that the US Federal Reserve would raise its interest rates sooner than expected.

For a worse-case scenario, he values the ringgit at RM3.45 per US dollar by year-end, while others think the value will stabilise around RM3.30 per US dollar.

“It’s still fluid at the moment as the trends of the economy keep changing. Many factors come into play, and we need to monitor developments in other economies,” an analyst says.

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Saturday March 20, 2010

Currency trends

By CECILIA KOK