Subir Gokarn
Chief Economist
CRISIL
The pressure on China to allow its currency, the yuan, to float has been intensifying over the past few months. The US trade deficit with China is humongous and this typically stokes protectionist sentiments in that country.
China's east Asian competitors will also be pleased to see the yuan appreciate, which is the only direction in which it can go if it is allowed to float.
However, China has held firm, resisted all the pressures so far and does not show any signs of yielding in the near future.
Its appetite for accumulating reserves in order to peg the value of its currency relative to the dollar appears limitless. At some point, this must force the central bank to give up control over money supply.
believe that point should have passed some time ago, but China's economic managers continue to surprise the world with their abilities.
Be that as it may, the only logical explanation for this obduracy on the exchange rate is that they believe that an appreciation will have enormous adverse impacts.
Is this a valid perception?
Some might argue that China's competitive edge in most of the products it exports is so great that a small appreciation will not have much effect.
It can, therefore, afford to be seen yielding to international pressure and earn some brownie points in the process. However, there is a strong counter to this view.
China's export basket is almost completely replicable by a number of countries in Asia and elsewhere.
Its products have absolutely no pricing power in global markets and margins are correspondingly low.
A small change in price could well push buyers to look for better deals elsewhere. The SARS episode illustrates just how vulnerable China is to disruptions.
A significant appreciation of the yuan could have an even greater short term impact.
There are two consequences of a disruption in exports. First, it is widely perceived that China's financial system is reeling under the cumulative weight of bad loans.
It needs a stable source of cash inflows to allow it to meet current obligations. Export revenues provide this stability in the current scenario.
If these were to dry up, the whole system could go in for a massive default. Of course, China is in good fiscal health, so the government could probably afford to bail them out, but any systemic crisis inevitably weakens the credibility of the government and the repair work that is required is more than just financial -- reputations and trust have to be rebuilt, which is a far more difficult task.
Better not to allow the crisis to happen at all.Second, with exports accounting for over 30 per cent of the GDP and coming from the relatively more labour intensive sectors, there could be significant dislocations in employment.
China did away with job security regulations gradually. As things stand, there is no compulsion on exporting units to keep people on the rolls if there is no business.
China is currently in a virtuous circle of growth in which exports support large-scale employment and these incomes, in turn, stimulate enormous consumption spending domestically.
Further, it is clear that the consumption boom is nowhere near an end. As many people as there are who can afford cars, mobile phones and other "luxuries," there are several fold more who are within sniffing distance.
A shock to the system, even a short-lived one, will unquestionably constrain these aspirations, not to mention increase the risk of widespread defaults by individual borrowers, thus dealing a double whammy to the financial system.
If this is the way the Chinese government is seeing things, it is certainly not hard to understand why they are willing to risk international threats and insults in order to maintain stability in their export performance.
One important difference between India and China is the way in which each deals with crisis. Crisis seems to bring out the best in India; our best policies have been invariably forged in precipitous moments.
On the other hand, the Chinese seem to loathe such situations and want to avoid them at all costs. Recent history suggests that they have enormous problems dealing with them when they do occur.
Arvind Singhal
Chairman
KSA Technopak
Indian exports have shown an encouraging resilience in the past 12 months and have exceeded $75 billion in the year ending March 2005.
Of course, every achievement these days seems to pale in comparison with China, which closed the year with almost $595
The prospects for Indian exports in the coming 12 months continue to look encouraging, although it must still be added that India still has a minuscule share of the global trade and, hence, even a projected growth of 25 per cent has to be seen in the context of the current low base.
In recent months, the global noise on the issue of float of the Chinese yuan has become shriller. The Indian exporting community seems to have joined in and some have started believing that yuan's revaluation is imminent and that it would make Indian exports more competitive.
Unfortunately, this could be yet another case of wishful thinking and misguided optimism.
First, there is no indication whatsoever that China is going to let the yuan go up dramatically. Most analysts believe that the revaluation, if and when it does take place, could be in the range of 1 per cent to 5 per cent over a period of 12 months.
In comparison, the Indian rupee is appreciating by 4 to 5 per cent every year for the past two years, and is likely to gain another 2 to 3 per cent before the end of the current fiscal.
With a better investment climate in India, inflows of foreign capital shall accelerate, potentially making the rupee even stronger.
Hence, any revaluation of yuan is likely to be matched by a similar revaluation of the rupee, maintaining the current parity between Indian and Chinese export competitiveness.
Second, there are limited areas of Indian exports that overlap with China as far as global trade is concerned. The most prominent overlap is in the textile and clothing sector.
Unfortunately for India, China has taken an unassailable lead with its exports clocking almost $100 billion compared with India's $14 billion in 2004.
India could have benefited tremendously from the quota phase-out but unfortunately, it has woefully lagged in making the requisite quantum of investment to add more capacity (and diversity) for exports.
Some growth will certainly be coming India's way but it wouldn't be because of yuan's revaluation but more because of India's competitive advantage in select textile and clothing product categories.
Third, the gap between China and India's productivity and competitiveness is far too much to be bridged merely by a small revaluation of yuan (even notwithstanding the corresponding likely revaluation of the rupee).
India has refused to acknowledge the choking weakness of its infrastructure and, hence, for most businesses the transaction costs continue to rise on account of high cost of real estate, transport, freight, power, and so on.
Further, critical areas of reform, such as those pertaining to labour, continue to elude India, further loading Indian businesses with lower productivity.
Hence, while China continues to achieve higher productivity that can potentially offset the impact of a stronger currency on its exports, Indian businesses have already picked up the low hanging productivity fruit in recent years, and can now achieve further improvements only when India makes dramatic investments in infrastructure and policy to enable reduction of operating costs and quicker addition of new capacity.
As the Chinese economy booms, it also becomes a large importer of merchandise. In recent years, India has benefited from higher exports to China of raw material such as iron ore and steel, cotton yarn, chemicals, cereals and so on.
With or without the yuan's appreciation, China will become a bigger importer in years to come, providing many countries to increase their exports to China itself.
In the short term, this could mislead some into believing that India's export competitiveness has improved.
China continues to add internal production capacity in almost every industrial sector and in the next few years it can reduce its requirement of imports in many areas other than in basic raw materials such as oil, ore and minerals, and, perhaps, food.
What is the message for India? We need to get our act together, rather than live on the hope of picking up crumbs left over by the Chinese juggernaut.
