Rapid yuan appreciation and the IMF

The emerging economies have successfully rammed the point home during the ongoing International Monetary Fund (IMF) annual meeting that the Fund must heighten the scrutiny of the currencies of the developed countries. This call was supported by the United States Treasury Secretary Timothy Geithner, who urged the IMF to play a “bigger role in monitoring how countries manage their currencies.”However, Geithner was not calling for heightened scrutiny of Western currencies and their government’s manipulation of key macro-policy tools that impact on their currencies, but was instead urging the IMF to pressurise China to allow its currency to rise in value against the dollar – an objective that the US believes is critical to ensuring a level-playing field as it accuses the Chinese government of manipulating its currency to gain trade advantages. In other words, it is Geithner’s contention that the rising US and European trade deficit vis-a-vis China, which contributes to the dollar as well as the Euro losing its value, is due to the decision of the Chinese government to keep the yuan below its market value with the overriding objective of making Chinese products more attractive to the recession-ridden Western buyers.

The US accusations have relevance, given that China’s trade surplus was a whopping 11 percent in 2007 and 5.8 percent in 2009 at a time when the rest of the world was reeling from a recession. China’s target in response to Western concerns: to reduce the trade surplus to 4 percent of the Gross Domestic Product in three to five years. The Chinese Central Bank Governor Zhou Xiaochuan resisted calls for faster appreciation of the yuan by claiming that China would avoid ‘shock therapy’ and “China’s exchange rate policy is based on the market supply and demand relation to move gradually to the equilibrium point.”

Failure to convince the Western economies that China is indeed on the most tenable path to end yuan manipulation that takes note of not only its own economic considerations, but also takes note of global concerns is critical if the Western economies are not to slap tariffs on Chinese imports in an effort to make Chinese products uncompetitive in their economies. Already there is talk of the European Union renewing and raising duties on Chinese magnesia bricks that are used in steel-making for another five years to as high as 39.9 percent, and Vestas Wind Systems, the world’s largest turbine maker is planning to counter Chinese competition by expanding into areas of lower speed with more efficient wind machine blades.

In response to Geithner’s call, the IMF chief economist Olivier Blanchard stated that “Clearly the issue of external rebalancing is becoming more and more important and as a result, the issue of the exchange rate adjustment is becoming a more and more important one”. However, he added that “I am optimistic the G20 can actually work out a solution, we are just at the beginning of the process, so it’s much too early to declare it a failure.”

The question of course is whether the IMF can play a role in arresting currency wars in an effort to narrow unfairly high trade deficits. The IMF’s fundamental mission is “to help ensure stability in the international system. It does so in three ways: keeping track of the global economy and the economies of member countries; lending to countries with balance of payments difficulties; and giving practical help to members.”

While the developing world, including Pakistan, has been engaged with the IMF as a lender of the last resort and has accepted advice, in turn, by complying with quantifiably monitorable performance indicators, it is not that easy for the IMF to compel its more powerful members to follow its prescriptions.

Thus, while it is within the IMF’s purview to monitor and ensure stability of the international system, however its effectiveness would remain a function of the rich 20 member countries accepting its role as the enforcer of a fair and free currency system. Clearly, there is no such unanimity with respect to the Chinese yuan and at this stage threats and counter-threats, intermixed with some negotiations, are underway between the Chinese government and Western economies – Brecorder