In a milestone move, China expanded the trading band of its currency, the yuan, against the US dollar on 14th April. That, according to most analysts, underscores its ambition to liberalise its nascent financial markets and turn them into a global force. The statement released on its website by the People's Bank of China said that "from April 16, 2012, the renminbi exchange rate against the dollar in the spot interbank currency market will be widened from 0.5 percent to 1.0 percent."
In other words, the yuan, which was earlier allowed to rise or fall by 0.5 percent against the dollar, will now be permitted to fluctuate in the range of 1 percent on a daily basis from a mid-point set by the Bank. The IMF chief Christine Lagarde welcomed China's move by terming it an "important step" and adding that "this underlines China's commitment to rebalance its economy towards domestic consumption and allow market forces to play a greater role in determining the level of the exchange rate." The reaction from the US was, however, more cautious. A top administration officer, Ben Rhodes told reporters that China has "made some progress, we would like to see more movement. We noted this announcement. We are reviewing it closely."
There is of course a long history behind China's latest move on the yuan exchange rate. Beijing's trading partners, especially the US and the EU countries, have been severely criticising the exchange rate of China's currency in the past that it is undervalued and has triggered huge trade imbalances between China and its major trading partners in particular. Of course, an undervalued yuan has discouraged imports into China and reduced domestic consumption demand, tilting the balance of Chinese GDP in favour of exports. China's reaction to such accusations has generally been mild.
It has usually avoided direct confrontation and often signalled to loosen its grip on the value of yuan as it moves to full convertibility, but has rejected calls for a faster appreciation for fear of hurting its manufacturing sector, a key driver of its economy. The announcement by the Bank of China on 14th April would mean that the yuan would now be allowed to fluctuate further against the US dollar but not necessarily as much as China's trading partners would like. However, it may be mentioned that the decision to widen yuan's trading band has come at a time when the pressures for its appreciation from the rest of the world had eased somewhat after recent data showed that the country's trade had become more balanced than before. It means that China is now more prepared to enhance the flexibility of its currency and bring the value of its currency in line with market forces. If this is true, China could become a major player in the world financial markets over time, play a more useful role in reviving other economies and lay to rest the growing fears of protectionism in the world economy.
Above all, such a move would ensure that ordinary Chinese would be able to increase consumption levels and enjoy standards of living commensurate with their efforts and earnings. All these developments would be welcome for the world economy. However, whether the present Chinese action could be interpreted as a change in policy strategy on a permanent basis or a temporary step to avoid harsh criticism from the US and other developed countries for the time being would only be apparent in due course of time. Nonetheless, the IMF response to the Chinese move needs to be particularly noted.
Although China, has only widened the band of trading of its currency and still is far away from market-determined exchange rate, the IMF has welcomed it, terming it an important step. On the other hand, when some developing countries try to negotiate a programme with the Fund, it is forced to adopt market-determined exchange rate without listening to its pleas to allow a gradual shift towards a free-floating exchange regime. In a way, this clearly speaks of double standards but in the real world, the merit of the argument could always be twisted to suit the status and power of the parties involved.
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