Though it is still a close call, we believe it is becoming less likely that China will be explicitly named as a "currency manipulator" in the US Treasury's semi-annual report, expected to be released next week. Pressure for immediate action is easing slightly in the wake of PBOC's rate hike and given that Congress has become more focused on domestic issues. Instead, a more "neutral" wording could be used that avoids the term "manipulator" yet still keeps the pressure on China to move faster. Such a "not guilty" verdict would be more politically conducive for the Chinese to move faster, which has been promised repeatedly by the Chinese leadership ?
There is no question that fundamentally there is a strong case for faster CNY appreciation. Yet, because the Chinese authorities know very well that the Renminbi issue has become one of the most politically charged issue in the US, it is not surprising the Chinese have also been playing the issue in a political way.
We continue to hold the view that USD/CNY should move down to 7.3 by the end of the year. The risk to the fundamental-driven forecast however lies in the political and policy complications, both on the China and the US sides.
From a speech by US Treasury Secretary John Snow on the recently released Report on International Economic and Exchange Rate Policies, in which the US did not name China a currency manipulator, May 10, 2006:
Let us be clear: we are extremely dissatisfied with the slow and disappointing pace of reform of the Chinese exchange rate regime. The RMB's appreciation has done little to curb China's large current account surplus or cool its fast-growing economy, which last quarter was at an over 10% annual rate. Further exchange rate flexibility is a key tool for tightening financial conditions amid ample liquidity, reinforcing the effect of recent monetary policy actions aimed at cooling economic activity. Thus, this slow pace is neither in China's self-interest nor in the interest of the world economy. With a still-rigid exchange rate, China lacks effective monetary policy tools to avoid the boom-bust cycles it has experienced in the past. This is particularly important now that investment in China appears to be reaccelerating, increasing the risk of a hard landing.
From "The Right Call on China" by Morgan Stanley chief economist Stephen Roach, May 11, 2006:
The US Treasury was in a lose-lose position insofar as the current groundswell for protectionist actions is concerned. Had China been judged guilty of manipulation, the Treasury report would have fueled the bandwagon of protectionism. But now that Treasury has failed to render such a verdict, the politicians are arguing that the Administration has once again let China off the hook. The currency report has, in effect, become a lightning rod for the debate over US trade policy. That could well be the biggest risk of all. With Washington expending excess political energy on China-bashing, it runs the real risk of failing at the most important task of rebalancing – addressing America's unprecedented saving deficiency. In my view, the Treasury report was a solid effort in presenting a balanced case on the so-called China problem – defending the adjustments the Chinese have made while putting considerable pressure on them to do more.