In the midst of the urgent attention accorded globally to addressing the financial crisis, external pressure on China to let the renminbi appreciate has subsided. With weak global commodity prices, internal pressures from China’s domestic commodity buyers have also eased.
The absence of those pressures, combined with sagging exports, has effectively halted the steady march upward of the renminbi that began with the "basket of currencies"trading band policy in 2005. For nearly a year now, the Chinese currency has held steady against the US dollar. Officials have publicly announced their intention to keep it there, as they try to jumpstart export growth and face other urgent imbalances.
But the renminbi has been much in the news, and this time it is China’s doing. Since late 2008, Beijing has made nearly US$100 billion in external commitments of renminbi funds, in currency swaps, foreign central bank provisions, loans and grants associated with commodity contracts, and export credits.
There are two interesting aspects to this. First, the projection of the renminbi outward began even before Zhou Xiaochuan, the central bank’s governor, made cautionary remarks about the US dollar and called for an international currency to stablize global markets. It began before other Chinese leaders joined the chorus warning that US policy was setting the stage for an era of dollar decline and global inflation.
Secondly, official pronouncements of this new policy carefully state that China is planning an "international role"for the renminbi, not "internationalizing"it. The point of that distinction is to detach the development of currency from a timetable for its convertibility. China wants the renminbi to be a trade settlement currency specifically because it is more stable than the dollar.
Have your cake and eat it
Achieving an international role for the renminbi without surrendering these basic controls over convertibility and bankability has proven to be difficult, resulting in delays in implementation and the publication of governing rules.
There are two paradoxes not easily resolved in the new policy.
The first paradox is that increasing foreign exposure to the renminbi, through export credits and currency swaps, will put larger amounts of the currency into the hands of owners and traders outside China. This will, in turn, increase the number of market-based data points defining its real value. There are already substantial street markets for renminbi in several Southeast and Central Asian nations, and even the formal export credits will need to be negotiated in local currencies for commercial importers.
The second paradox is that diplomatic pressure for further renminbi appreciation against the US dollar has indeed subsided. But there is a deep inconsistency in the announced policy to hold the renminbi steady against the US dollar, on one hand, and promote its use for trade settlement with the argument that it is more stable than the dollar on the other.
A biased basket
Since the "basket of currencies"system was introduced, the renminbi’s gain on the dollar can be drawn as a steady, smooth curve. Against the euro, the renminbi plots an erratic curve – almost identical to the US dollar plot against the euro. This suggests that the renminbi is still primarily if not solely tied to the US dollar. But if the renminbi is to function internationally as a more stable alternative to a depreciating US dollar, then it cannot avoid resuming appreciation, potentially steeper than the 6-7% a year between 2005 and 2008.
Put simply, the renminbi cannot achieve credibility as a more stable alternative to the US dollar if it is primarily a dollar surrogate, no matter how strong China’s reserve position is.
In fact, China’s reserve position suggests it has enough stake in the stability of the US dollar to continue purchases of dollar debt – and, in the interests of export competitiveness, moderate renminbi appreciation – no matter what new, external markets say. Yet, at the very least, the new policy creates a new group of stakeholders who will want to see the currency appreciate, especially if they are beneficiaries of swaps or credit facilities.
It may be ironic that what economic diplomacy failed to achieve in opening the renminbi to market forces may be brought about by China’s own intitiative to benefit from its perceived stability internationally. Or maybe it is all according to plan.