Monthly Archives: June 2010

China’s Exchange Rate Policy Switch Not All It May Seem

We have long argued that China would allow its currency to appreciate, as much of the rest of the world is demanding and which in the long-term is in its own economic interest, but that it would do so at a time of its own choosing. That indeed has been Beijing’s public position regardless of the volume of the rhetoric coming out of Washington and Brussels. Today’s unexpected announcement by the People’s Central Bank of China that it will return to its pre-financial crisis managed floating exchange rate regime introduced in 2005 to replace the yuan’s peg to the dollar but suspended in July 2008 following the onset of the global financial crisis, is more style than substance, though there is some substance there.

No one should think, though, that Beijing is letting the currency float freely. The central bank is explicit that there will be no ‘large-scale appreciation of the yuan” and that the previously used narrow bands within which the currency can move will be re-instituted. That means that any appreciation in the exchange rate is likely to be modest and gradual. And while the announcement comes ahead of the G20 summit in Toronto, with the intention, we assume, of taking some of the sting out of the issue there, there is no indication of the timetable by which it will be implemented. We don’t expect the central bank to be in much of a rush. Nor do we think that all China’s economic policymakers are yet convinced of the solidity of global economic recovery that allowing the yuan to appreciate would imply and which the central bank cites as a justification for the policy switch.

There is also an opaque reference in the central bank’s statement that “continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies”. While no one has known exactly what the composition of the reference basket was, beyond being overwhelmingly U.S. dollars, given the changing nature of China’s trade over the past couple of years, the new mix could have a material effect on the politically sensitive U.S. dollar-yuan rate that would mean that rate not moving much, and the yuan-euro rate moving more, a combination that wouldn’t appease the increasingly bellicose critics of China in the U.S. Congress. If the euro remains weak, the yuan could conceivably depreciate against the dollar, which would really put the cat among the pigeons.

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Kyrgyzstan Airlift Concluded

The evacuation of Chinese nationals from Kyrgyzstan has been completed with a ninth flight bringing out the last of 1,299 people airlifted home, Xinhua reports. The evacuation started three days ago after ethnic violence broke out between Kyrgyz and Uzbeks, which has left at least 187 dead and the country facing what the Red Cross is calling “an immense” humanitarian crisis.

Many of those evacuated were businessmen and their families and construction workers in Osh, the southern Kyrgyzstan town close to the Uzbekistan border, and who come from Xinjiang. A foreign ministry official said the “vast majority” of Chinese nationals in Osh had been evacuated though some Chinese were remaining in Kyrgyzstan.

When ethnic violence broke out between Kyrgyz and Uzbeks 20 years ago, the old Soviet Union sent in troops to restore order in short order. Russia is unlikely to play a similarly firm role this time round, though it will be part of any international or CSTO peacekeeping force that goes into Kyrgyzstan. The current provisional government that ousted that of Kurmanbek Bakiyev in April clearly has no control of the country. While the geopolitics are complicated by Russia’s traditional influence and the presence of a U.S. military base, there is a high probability that the interim government could collapse and Kyrgyzstan, or at least its southern part, fall into ungovernable chaos.

The most troubled area is in southwestern Kyrgyzstan where Kyrgyzstan, Uzbekistan and Tajikistan meet in the Ferghana Valley but, to the east, China shares a long border with southeastern Kyrgyztsan and will be regarding the prospect of a lawless state on one side of it with great concern, especially as its own side of it has Muslim minority issues of its own with Xinjiang’s Uighurs.

The chaos also underlines an aspect of China’s policy of using its money to extend its influence across the stans (and by extension curtailing that of Russia and the U.S.) by developing commercial and economic links and providing ample dollops of patronage for local politicians. It is a policy that depends on there being stability.

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No Let Up To Rainy Season As Death Toll Mounts

More heavy rain is expected in in the already inundated southern provinces, raising fears of more loss of life from mudslides and flash flooding particularly in Fujian, Hunan and Guangxi. At least 35 people have died and 49 are missing following this week’s seasonal downpours. In Sichuan on Tuesday, 23 people died when a landslide cascaded down a mountain into dormitory tents on a construction site. Across western and southern China, more than 100,000 have been evacuated from their homes, Xinhua reports. In all, more than 150 people have died so far as a result of this year’s rainy season.

Update: More than 2.5 million people across six southern provinces have been affected by this week’s rain and 238,000 had been evacuated from their homes, the Ministry of Civil Affairs said on Thursday, adding that more than 33,000 homes had collapsed or been damaged. The known death toll has risen to 46.

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Kyrgyzstan Airlift Continues

China has now evacuated nearly 1,000 of its nationals from Kyrgyzstan, where ethnic violence has left at least 170 dead, Xinhua reports. Seven evacuation flights have been undertaken with at least two more planned. The air lift started earlier this week. Most of the evacuees are businessmen and their families or construction workers in the southern Kyrgyz towns of Osh and Karasu. The governments of South Korea, India, and Pakistan have organized similar air lifts.

Meanwhile Beijing is offering 5 million yuan ($731 million) in humanitarian aid in the form of medicine, medical equipment, food, drinking water, blankets and tents. Red Cross officials say there are shortages of basic necessities like food, water, shelter and medicine across the Uzbek-dominated south of the country where the violence has been most extreme and we are starting to get reports of atrocities. The officials guesstimate that “tens of thousands” of Uzbeks have been displaced within Kyrgyzstan while at least 75,000 refugees have fled into Uzbekistan.

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China’s Welcome Rising Wages

Much of the commentary about China written by non-Chinese, scholarly, commercial, journalistic, is written by Americans, as weight of numbers suggests it would. That may be, though, why historical perspective is often missing. America is a country where history is regarded as the refuse of the present rather than prologue to the future. As we read coverage of the strikes and pay rises at the likes of the Foxconn and Honda factories and of Uncle Wen Jiabao’s tribute to the migrant workers filling all the other workshops and assembly plants of China’s industrial heartland, this strikes us as being particularly the case when it comes to China’s economic development.

There is an arc to industrial revolutions. Economies transverse it in their own ways and at their own speeds, but they don’t avoid it. That is as true for China as it was for England, Germany, the U.S., Japan, South Korea and many others before it.  One characteristic of China’s industrial revolution is that it is being carried out under the umbrella of state-owned capitalism. Another is that, unlike, say, Japan, which became the low-cost export manufacturer to the world by taking labour out of manufacturing, China did so by putting low-cost labour in.

That was always going to be unsustainable as China’s industries started moving up the development ladder as they are now doing. One measure of that is the rising level of capital per employee. Another is the rising skill levels being required from workers. The inevitable consequence is a rise in productivity. The International Labor Organization’s most recent biennial international productivity study shows China’s productivity increasing by an annual average of 5.7% since 1980 (the figures run to 2006 but the trend is clear). Wages should be rising to reflect that, just as wages in England and America did at comparative stages of development. (Not that those pay rises didn’t come without their share of labor struggles.)

Even the scale of pay rises being seen at Foxconn, a special situation anyway, and Honda would not materially change retail prices for China’s exports. Labour accounts for about 5% of the price of consumer electronic goods like an iPhone. There a plenty of points along global supply chains where some if not all of any wage cost increases can be absorbed. If wage inflation is to push manufacturing out of the present industrial heartlands it is more likely to go to inland than to Vietnam or other lower-cost countries. True, some Western multinationals are looking at shortening their international supply chains, but that is more because of factors such as event risk (think volcanic dust disrupting transport) and carbon footprint concerns than labour costs.

There is one more reason to cheer rising wages in China. More money in the pockets of Chinese workers and thus more purchasing power. That is a prerequisite for domestic-demand driven growth.

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China Evacuates Its Nationals From Kyrgyzstan

China has dispatched two airliners to evacuate some 200 Chinese students and nationals caught up in the unrest in Kyrgyzstan. Xinhua reported that the first one is expected to land back in Urumqi overnight. Two further flights are planned for tomorrow. There are no reports of Chinese nationals being among the more than 100 reported dead in the outbreak of ethnic violence, but some Chinese-owned businesses are reported to have been looted.

Unlike Russia, China appears to have no plans for a military response. The prospect of civil war in Kyrgyzstan poses dilemmas for both Beijing and Moscow. Neither wants to be dragged into a potentially messy, ethnic conflict. But neither would be happy with a prolonged period of instability or civil war, which could easily spill over into neighbouring stans such as Kazakhstan, or even into the outer fringes of Russia and China itself.

Beijing and Moscow have been jockeying for influence in the region in recent years. Beijing won’t be thrilled to see a small Russian dominated peace-keeping force under the aegis of the Collective Security Treaty Organisation (the security pact between most of the former states of Soviet Central Asia) being deployed in Kyrgyzstan if the violence continues, but it may look upon it as the lesser of two evils, providing there is a fixed period to its deployment.

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Behind May’s Trade Figures

The latest monthly trade figures, for May, flatter to deceive in a couple of respects. Exports, at $131.8 billion, were up 48.5% year on year, but May 2009’s figures were abnormally low, amplifying the comparison. Second, trade with Europe, China’s biggest export market, remains robust, but that may mean that the impact of the euro-zone debt crisis has yet to affect China’s exporters rather than they have avoided it.

None the less, exports overall are at their highest level since September 2008 and the trade surplus, at $19.5 billion, was the biggest in seven months. Both confirm our view about the strength of China’s economy going into the third quarter, and of the global economy’s continuing recovery.

Whether all that is sufficient to bring about any change to the yuan’s peg to the dollar remains moot, to our minds. Those, particularly in the U.S., likely to get exercised over this again as a result of the May figures, should use the yuan’s 20% appreciation against the euro as a consequence of being pegged to the dollar as a reality check on the size of the effect any revaluation of the yuan against the dollar would have on China-U.S. trade.

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