Currency fall not the end of the world

Global markets need to put devaluation in perspective - as a strengthening of China's renminbi

The first conference on China I attended was a little more than a quarter of a century ago, in Centrepoint, one of the tallest buildings on the London skyline at the time. At the end of the conference, which about 300 executives attended, the chairman, Lord Sharp, retired head of the British company Cable and Wireless, asked those who saw China as a good long-term commercial prospect to raise their hands. There were none.

Of course, we now know how wrong that audience was, most multinationals, from Volkswagen and General Motors, to Exxon, L'Oreal and Walmart having profited hugely from Chinese growth. They see China as their most important long-term growth market.

Every year since 1990, somewhere in the West, at least one audible voice has warned that China's success is unsustainable, being built on sand, and that it will all end in tears. The voices have been more strident at times of obvious difficulty, such as the 1997-98 Asian crisis, when a big renminbi devaluation was a given, and the aftermath of the 2008 financial crisis when, to many, a debt-induced Chinese economic collapse was inevitable.

At times like these, China disaster books such as The Coming Collapse of China, The China Wars and The China Crisis, to name just three, proliferate. Even in good times the voices forecasting collapse do not disappear. But renminbi did not devalue against the dollar during the 1997-98 Asian crisis, and China has not collapsed as a result of its post-crisis credit boom.

The renminbi devaluation of Aug 11 surprised markets used to a Chinese currency that had appreciated steadily since 2005, even keeping pace with a strengthening dollar in recent years. For traders, the renminbi was a one-way bet. The markets dislike unexpected and sudden changes that challenge their firmly held assumptions, and they dislike losing money even more. So the renminbi devaluation was widely greeted with boos and catcalls.

To many commentators, the apparent motive was to provide much-needed help to a Chinese economy that had hit the buffers as the growth in popular economic indicators, such as electricity demand and rail-freight use, turned negative. Some commentators described the currency move as a last-ditch attempt to stimulate growth as the economy slows to stalling speed. For them, it showed that the Chinese government had lost control and was close to panic. Others saw it as the first shot in a new currency war, with the currencies of competing Asian economies such as Indonesia and Malaysia following the renminbi down in a death spiral.

So far the devaluation has been modest, the renminbi trading about 3 percent down against the dollar against its pre-devaluation level. The fundamentals supporting the Chinese currency - a strong trade account and balance of payments, with high real interest rates and low inflation - do not argue in favor of a steadily weakening renminbi. Both China and the International Monetary Fund regard the currency as fairly valued.

What about the Chinese economy? Is a weaker renminbi the last, desperate hope of a government that has lost control of its economy and needs to stem the fall in its exports? It is true that some economic measures indicate weakening, such as real estate demand, and the price of iron ore, for which China, by far the world's largest steel manufacturer, is the major buyer. Reports from car and fashion companies show that Chinese automotive and luxury goods sales have stopped growing. But other measures in other sectors present a different picture.

In June, Alibaba, one of the two big Chinese companies in online retail, reported an increase in Chinese retail sales of more than 20 percent year-on-year. In the second quarter, Ctrip, a Chinese leader in online travel and tourism, reported growth in packaged holiday revenue of 61 percent year-on-year. Other indicators of strong Chinese consumerism, such as life insurance and education, are also growing rapidly. The Chinese are famous for saving hard and spending carefully, but they can also spend big on items they consider important, or which are mass-market fashion statements, such as iPhones.

So parts of the Chinese economy are slowing but other parts are growing strongly. A change in the structure of the economy has begun, with the service economy now larger overall and growing faster, in terms of value-added and GDP contribution, than the huge manufacturing sector. China's middle class is on the move. The economic figures that were reliable 10 or 20 years ago as indicators of underlying activity, such as growth in energy demand from China's factories, have become less accurate as measures of what is really going on with the economy. How could Alibaba produce annual sales growth of 20 percent or 30 percent in an economy supposedly in trouble? Most commentators and analysts are receiving a distorted picture of the Chinese reality because China's statistical collection process is aimed more at its manufacturing and foreign trade sectors than at its service sector. It will take several years for the huge adjustment that has begun in China's economy to mature. But once the modernization and lifestyle changes visible today in Shanghai, Beijing and Guangzhou spread out, items of durable household spending, such as car sales, will start growing again.

The renminbi devaluation happened as China's export figures were showing sustained weakness, but a change in the renminbi's international value of less than 5 percent will have little impact on the volume of China's exports, and the effect on the country's competitors will be minimal. The real significance of the small renminbi devaluation is a change in the country's currency system, from a managed one toward a free float, with less direct intervention by the central bank.

The recent report by the IMF on the way it evaluates the major reserve currencies - those that global central banks hold as part of their key financial reserves - was the real trigger for China's currency move, because it would like renminbi to join the US dollar, the euro, the Japanese yen and the British pound to become a global reserve currency. Reform in China often follows from membership of important global institutions, as occurred after the country joined the World Trade Organization in 2002. Once renminbi becomes a reserve currency, the market will play a greater role in pricing China's money. In turn this will encourage confidence and transparency in the management of the country's economy, as well as greater economic efficiency translating into higher growth.

This month's currency move should be seen mainly as yet another sign of China's determination to reform and modernize its economy by taking a big step toward the requirements of a reserve currency. Once global markets have settled down and seen that the move is not the beginning of a large devaluation of renminbi they will doubtless welcome the move for what it is and give it the support that it deserves. In the longer term, the currency move will probably underpin renminbi, not weaken it.

The author is a visiting professor at Guanghua School of Management, Peking University.

The views do not necessarily reflect those of China Daily.