Friday, 20 November 2015

China's trade surplus - The Economist

Despite the continuing global demand for Chinese products, there is one more element that has been playing a crucial role in ensuring China's trade surplus in the recent years. It's the renminbi - the Chinese currency.

Being an export-heavy nation, China knew that it had to keep its currency lucrative enough for its trading partners. This incentivized China to keep the value of renminbi low and a managed float seemed to be a feasible way. Besides, this also eliminated the level of payment uncertainty from the minds of Chinese exporters and importers.

Benefits of the Managed Float System vis-à-vis the Fixed Exchange Rate Regime

· Ability to ease out the strict capital controls that were in-built into the system to facilitate a fixed exchange rate regime

· Accumulation of low-yielding foreign reserves (compared to other forms of domestic investments within China) due to more demand for renminbi was a major cause of concern under the fixed regime. Along with this, inflationary pressures were always prevalent. With a flexible system the impact of such issues can be reduced as circulation of renminbi within China can be controlled in a better manner.

· Huge exposure to USD (around 50% of GDP) as the primary foreign reserve means that even a marginal drop in the value of USD can be detrimental to the Chinese economy. With flexible regime, this risk can be eliminated to a certain extent as depending on situation, China can take up exposure in other non-US foreign reserves in a better manner.

The Ultimate Goal

From the above discussion it can be seen that China made a smart move to switch from the fixed exchange rate regime of the late nineties to the managed float system in 2006. In the process, renminbi appreciated 21% against the dollar before it was again repegged to the USD in August 2008 in a move to protect Chinese exporters who felt the heat of diminished consumer appetite amidst the global sub-prime crisis ignited in the US. As demand conditions started improving, renminbi was again moved to the managed float system. This move was also seen as a precursor to the People's Bank of China (PBOC) inching towards making renminbi a global reserve currency. Although this is far from reality, China has made progress in inking trade agreements with selected countries and launched a series of currency swap agreements with more than 20 central banks around the world.

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