Great expectations from China S. VENKITARAMANAN
China achieved more success than the US and other countries in stimulating its economy because it focused on infrastructure development before the onset of the slowdown. However, China may consider converting the renminbi into an international currency to take care of its bloated reserves, says S. VENKITARAMANAN.
The Western media has been engaged in recent weeks in analysing the prospects of China coming to the rescue of the global economy. The issue of Time dated August 10, 2009 has an article discussing the possibility of its economic resurgence. China’s economic growth has , of course, been exemplary. While it has grown at robust rates, its GDP has depended, to a large extent, on demand for its exports in US and Europe.
One view is that China is fast on its way to surpassing Japan as the second largest economy in the world. China’s economic growth has contributed to more than 70 per cent of the world’s economic growth in recent times . Further, fortunately for China, the Chinese economic stimulus package has worked far better than the much-touted stimulus package of the US administration.
SUCCESSFUL STIMULUS
One reason why China’s economic stimulus package has worked is that its stimulus package focuses on government spending on infrastructure projects. The Chinese authorities were already in the midst of an aggressive programme of building infrastructure, even before the onset of the slowdown .
The additional money given for the stimulus package could, therefore, be readily absorbed by readymade projects. Meanwhile, in the countryside, the authorities have been busy spending the stimulus package on infrastructure projects. These initiatives will provide a boost to the economy, besides improving its manufacturing efficiency and export competitiveness.
The Peoples’ Bank of China – its Central Bank – has also concentrated on providing additional loans to various infrastructure projects from the national banking system. This has meant that the fiscal economic stimulus package of government works more efficiently in China than in the US or elsewhere. Obviously, there was a risk that some of these large loan funds could flow into equity or real estate. The Chinese authorities are fully aware of the dangers of such mishaps.
The fact that the economic stimulus package in China has succeeded is an illustration of how a determined government, which spends public money efficiently on well-designed infrastructure projects to stimulate the economy and ensure jobs and economic growth, can succeed in the current context.
Chinese monetary authorities and the government have worked in tandem to ensure that the objectives of growth and employment generation are not compromised.
BLOATED RESERVES
The growing strength of China in the global economy brings with it certain problems, both for China and the rest of the world. One of them concerns the aggressive policy of China in encouraging exports by maintaining competitive exchange rates. This has led to China’s reserves increasing over the years.
A recent report points out that China’s reserves amounting to $2 trillion are parked in dollar-denominated securities, mostly US Treasury bonds. China has legitimate concerns over the devaluation of the dollar.
A recent article in the Financial Times (FT) exploring how China is trying to find its wayout of the dollar trap points out that if China tries to diversify its dollar holdings by selling its US Treasury securities and moving into other currencies, it will damage further the value of the US dollar and will reduce the value of its residual holdings.
The Chinese dilemma is thus obvious. It can content itself by threatening to move out of US Treasury securities. But, if it carries out its threat by selling its Treasury holdings, it would be acting in a self-destructive manner.
According to an FT article, China is, however, exploring the alternative of making renminbi (the Chinese currency) an international currency. That is to say, instead of trades into and out of China being settled in dollars, which are then converted into renminbi, China would, under the new alternative, encourage settling in terms of renminbi itself. The article points out that this may not be such an out of the way solution.
Much of Chinese trade, other than with US, is conducted with emerging market economies, who are familiar with settlement in renminbi.
The FT reckons that such a mode of settlement will make the renminbi one of the most active foreign currencies so far because of the size of Chinese trade with other emerging market economies.
China is already encouraging trade denominated in renminbi by subsidising exporters and importers who quote in that currency. Internationalisation of renminbi and its emergence as foreign currency is thus not out of reach. But whether this will by itself solve the problem of China’s accumulated reserves is doubtful.
CURRENCY OPTIONS
Owning a reserve currency as the national currency is a course fraught with certain problems. It tends to magnify every trade fluctuation into a currency crisis. It was for this reason that Japan consciously avoided the use of the yen as a reserve currency. China’s ambition may, however, be for renminbi to take its place alongside the dollar, establishing itself as a global reserve currency. The middle kingdom aspires to be a real successor to the US and the UK!
Further consequences follow from the move to internationalise the renminbi. China will have to liberalise its capital account rules. China’s corporates and individuals should be free to move their wealth into and outside the country without any permission from the government or the monetary authority. Capital account convertibility seems to be a prerequisite for any currency becoming a reserve currency.
If China is to play a significant role in the world’s future alongside the US and Europe, it will have to move towards renminbi also becoming an internationally used currency, both for purposes of trade and other settlements. This will call for fundamental changes in China’s economic management.
China has, in keeping with its growing economic strength, asserted itself in international economic management. It has played an increasing role in the World Bank and the IMF. To wit, it is likely that G-8 is reduced to G-2 — the US and China. Will India try to forge a strategic alliance with China in future? The path of wisdom is to recognise China’s increasing prowess in global economic affairs and form an alliance with that mighty nation. We have a lot to gain and little to lose by focusing on a China-India bloc.
China’s future role in the international dialogue across various countries and financial institutions depends on its success in handling the impact of the global economic crisis on its own economy. So far, China’s success seems to have surpassed all other countries. It has benefited from its conscious policy mix of state control and market-related economic management. India has a lot to learn from China’s success.
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