Misplaced concerns over Chinese currency

Last couple of years, there have been a rising demand among a section of policy makers to accuse China of keeping its currency undervalued, and thereby gaining an unfair trade advantage for its exports. A recent meeting of G-20 finance ministers and central bankers, India and Brazil too lent their voice calling for a stronger Chinese yuan. But Jagdish Bhagwati & Arvind Panagariya, two eminent Indian economists based in Columbia University, argue that "India errs by lending its voice to calls for a stronger Chinese yuan", in the Economic Times, on 3 May 2010.
Economic Times

For some time now, the US Congress and some Washington think tanks have aggressively sought to turn the bilateral exchange rate issue between the US and China into a multilateral issue. They have done this by asserting that the undervaluation of the Chinese currency hurts not just the US but Asia and others as well.

The underlying argument is based on a syllogism. The first argument is that an undervalued renminbi is the root cause of the Chinese current account surpluses and the US current account deficits. The second argument is that the export expansion so achieved by China robs countries such as Brazil and India of their export markets... ...

But neither argument is acceptable. Consider first the error in the second argument. Just because China fixes its exchange rate against the US dollar does not mean India cannot choose the value of its currency against the dollar or other currencies including the renminbi at the level it sees appropriate for itself. What happens to India’s exports and imports depends on what it does to its own exchange rate, money supply and fiscal deficits and how its savings and investment are balanced... ...

The exports-to-GDP ratio grew from a low of 11 per cent in fiscal year 1997-98 to 23.6 per cent in 2008-09 . This was a faster expansion of India’s exports than during any other 11-year period in its history. If the Chinese dollar peg during 1997-2005 had any effect on India, the movement in the rupee’s exchange rate more than neutralised it... ...

Besides, the more than 18 per cent appreciation of the renminbi vis-a-vis the dollar between 2005 and 2008 made little dent in the US current account deficit. From $631.1 billion in 2004, it rose to $748.8 billion in 2005 and $803.5 billion in 2006 before declining slightly to $626.6 billion in 2007 and $706.1 billion in 2008. Going by these numbers, the exchange rate is surely at best one of many factors explaining the US current account deficits.

The US runs a current account deficit with more than 100 countries, including very large deficits with Germany and Japan. The combined current account surpluses of Germany, Japan, Switzerland and Norway far exceed the current account surplus of China. If one believes in the primacy of the exchange rate as the explanation of current account imbalances, one would have to call for these countries also to revalue their currencies! ... ...

India also makes a major tactical error by lending its voice to the calls for the appreciation of the renminbi. With its savings rate high and rising, it too could run into the Chinese “problem” of a current account surplus. It is surely a mistake then to go down this road where shortsighted US politicians and their enablers would have us go. Politically also India makes an error by taking sides in what is essentially a China-US issue. We have enough problems with China not to want to add a gratuitous one. Will the prime minister take note?