Words, not deeds

Release those tenterhooks. After months of procrastination, the People’s Bank of China (PBoC) has thrown its weight behind the resumption of renminbi appreciation. Well, nearly. It has said there will be some degree of flexibility in the currency’s exchange rate as opposed to rigidly sticking against the US dollar.

Not that Beijing admitted to maintaining an effective peg to the dollar; making its announcement, the PBoC said that since 2005, "the reform of the RMB exchange rate regime has been making steady progress, producing the anticipated results and playing a positive role."

In reality, of course, the renminbi had been pegged at around 6.83 to the dollar since the global economic downturn began in 2008.

Given China’s distaste for appearing to cave into unilateral outside pressure – from the US in particular – an announcement on the currency around June’s G20 meeting was always likely. Now comes the hard part: The PBoC must act on its promise or risk worsening already-strained relationships with its trading partners.

That is not to belittle the importance of the announcement. Europe’s debt worries, a falling euro and fears of a renewed recession had some predicting that China would continue to drag its feet, and there is no doubt that more conservative elements in Beijing resisted any change.

However, even sticks-in-the-mud must have recognized that delaying would not have helped China either at home or abroad. The argument that exporters couldn’t afford to be hit by a stronger currency was weakened by data showing exports grew 48.5% in May over the previous year. If anything, Beijing could use a way to cool the economy as inflation continues its upward creep  – it rose 3.1% in May – and annual GDP growth races toward 10%.

The weeks before the announcement saw the return of aggressive US rhetoric on the renminbi, even from officials who had previously been sympathetic to China on the issue. Frustration grew following the US-China Strategic and Economic Dialogue, at which President Hu Jintao promised – or appeared to the US to promise – progress on the exchange rate issue. To many in Washington, that pledge seemed to evaporate the moment the American delegation went wheels-up.

In helping to deflect the growing waves of criticism, the PBoC’s move is reminiscent of the initial unpegging of the renminbi in 2005: A one-off, 5% revaluation silenced critics of the peg while affecting the currency’s value little enough that any negative impact on exporters was relatively limited. The gradual appreciation that followed was important, but less crucial in shaping perceptions than the good PR generated by the initial jump.

This time, the PR campaign will be trickier. There will be no repeat of the one-off appreciation and, for the time being, the PBoC won’t liberate the currency from its existing trading band. This is perhaps understandable in a weak global economic environment, but Beijing must convince other countries that it intends to pursue real flexibility. While the PBoC’s language was intentionally vague, trading partners will not be impressed by attempts to dodge the issue.

China has bought itself some time and goodwill, which will probably allow it to hold off the critics at least through the G20 meeting. However, the muted reaction of world leaders to the announcement – US President Barack Obama said merely that it was a "constructive step" – is a sign that the patience will not last forever.

Nor should it: Despite all signs that the renminbi is undervalued by at least 20% (less charitable estimates put the number closer to 40%), the PBoC said that the currency would remain "basically stable at an adaptive and equilibrium level." Those are not words of a central bank that believes its currency is undervalued, and this is reason for concern.

The PBoC’s renewed embrace of the idea of a flexible renminbi should be welcomed, but China now has a responsibility to follow through on its words. As the G20 nations gather in Toronto, they should not allow what might amount to little more than a goodwill gesture from Beijing to detract from pressure for further reform. Inaction will only encourage inaction.