New global imbalances and renminbi

1
New global imbalances and renminbi

• Masaru YOSHITOMI
• Research Institute of Economy, Trade and Industry
  (RIETI )
• September 2004

2

• What further complicates institutional
  reforms in China is the emergence of new global
  imbalances, featured by a large US current
  account deficit at 5 percent of GDP, the major
  counterpart of which is current account surpluses
  of all East Asian economies including Japan. This
  time, the counterpart of the US external deficit
  is shared more or less equally by Japan and East
  Asian emerging economies, standing in sharp
  contrast to the 1980s when Japans surplus was
  the essential counterpart of the US deficit at
  3.5 percent of GDP.

3

• Therefore, the issue of renminbi is bound to
  be discussed in this Pan-Pacific context as well
  as in a consistent manner with ongoing economic
  integration in Asia. The renminbi issue is
  two-fold (1) its level, regarding whether
  renminbi is undervalued or not, and (2) its
  exchange rate regime, regarding whether it
  should float or remain fixed.

4

• Two macroeconomic criteria for renminbi
  adjustments
• For the former issue, there are two
  macroeconomic criteria for judging whether
  renminbi should appreciate or not. First, if
  Chinas current account surplus/GDP ratio has
  been rising over time, appreciating of renminbi
  will be required for containing such increasing
  imbalances. However, there has been no rising
  trend of Chinas surplus/GDP ratio in recent
  years (Table). The second macroeconomic criterion
  is whether foreign reserves accumulation is
  causing high domestic inflation through the
  expansion of the base money. In China, CPI
  inflation rate was minus 0.8 percent in 2002,
  plus 1.2 and percent in 2003 and accelerated to
  45 percent in the early 2004 but somewhat slowed
  down in recent months thanks to the introduced
  administrative control on bank credit.

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• From these two criteria, there were no
  immediate reasons for renminbi appreciation. A
  major source of increasing foreign reserves in
  China is massive net inflows of FDI, which
  account for above 5 percent of GDP in very years
  compared with 1.52 percent current account
  surplus/GDP ratios. Therefore, it is desirable to
  modify excessively favorable tax treatments of
  incoming FDI by many provinces and finance some
  portion of FDI by issuing bonds denominated in
  renminbi. Liberalization of outward FDI is also
  welcome.

6

• Against the background of the large US
  current account deficit, already accounting for 5
  percent of GDP in 2003, there will be the high
  possibility that the US deficit will be too large
  to be sustainable, so that a large depreciation
  of the US dollar may become inevitable in the
  near future . By then, the aforementioned two
  criteria may turn to justify renminbi
  appreciation. Therefore, the new global
  imbalances will be simultaneously addressed by
  exchange rate adjustments of both US dollar and
  Asian currencies including renminbi.

7

• What are appropriate exchange rate regimes?how to
  resolve the trilemma??
• Additional two issues will arise. One is
  what kind of exchange rate regime will be more
  appropriate for renminbi and other Asian
  currencies. The other is how the adjustment
  burden of currency appreciations and domestic
  absorption policies should be shared and designed
  for Asia and on the basic of what criteria.

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• The choice of exchange rate regimes, in my
  view, depends on two basic factors. One is how to
  resolve the so-called trilemma discussed in
  international monetary economics. That is, three
  policy goals of (1) fixing exchange rates, (2)
  free capital movements, and (3) independent
  monetary policy aimed at low inflation and high
  employment can not be simultaneously achieved. In
  other words, one of the three goals has to be
  sacrificed. For example, a sacrificed goal is,
  under the gold standard till 1914 or currency
  boards, is independent monetary policy. Under the
  Bretton Woods system, free capital movements were
  sacrificed. And then, under float regime since
  1973, fixing exchange rates was sacrificed
  (Table).

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• However, many emerging market economies are
  fearful of free float. This fear of float
  reflects the shallowness and the narrowness of
  their domestic financial markets which are
  responsible for volatility of floating exchange
  rates. Underdeveloped forward and swap
  instruments can not efficiently hedge spot
  exchange rate fluctuations and such risks, which
  in turn adversely affect external trade
  development of Asian emerging economies whose
  aggregated exports and imports often account for
  50 to more than 100 percent of GDP, unlike the
  case of G3 economies.

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• Furthermore, currency misalignments in the
  medium-run caused by continued capital flows
  substantially disturb the resource allocation
  between tradables and non-tradables. Therefore,
  crawling band systems can be recommended for
  emerging economies in Asia. The band can be
  widened in correspondence to the development of
  domestic financial markets.

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• In order to protect the upper band as well
  as to mitigate the aforementioned double
  mismatch, the Chilean type of capital controls on
  short-term capital inflows could be introduced.
  Chile utilized unremunerated reserve requirements
  (URR) and minimum holding periods (MHP) on all
  and any types of capital inflows.

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• Furthermore, in order protect the lower band,
  the regional lender of last resort facility
  should be established, by pooling a portion, say
  10 percent, of huge foreign reserves accumulated
  by individual East Asian countries. This facility
  will not only economize too much accumulated
  foreign reserves with low rates of return, but
  also protect the lower band of the crawling
  exchange rate regimes in case of a capital
  account crisis which requires not only the far
  larger amount of international liquidity beyond
  member countries quotes but also its quick
  delivery at the extremely good timing.

13

• These financial arrangements are very different
  from the rescue operation for the case of
  conventional current account crises. Only
  conventional crises can be managed by traditional
  stand-by arrangements and macroeconomic
  stabilization policies by the IMF. For
  geopolitical reasons, the United States, that is,
  either its congress or IMF strongly influenced by
  the U.S. can not function as international lender
  of last resort, particularly when American tax
  payers may have to bear the burden in case of
  defaults of borrowing countries from the lender
  of last resort facility.