Year of the Tiger: China outlook, 2010

By Wendy Diao and Marc Chandler
There are two major current account imbalances in the world — the U.S. deficit and China’s surplus — and both have fallen sharply. The U.S. deficit has been more than halved, from $219 billion in the third quarter of 2006 to $99 billion in the third quarter of 2009. China’s current account surplus shrank proportionally: It stood at 9.8 percent of GDP in 2008 and the World Bank expects it to fall to 5.6 percent in 2009 and 4.1 percent in 2010. In dollar terms, it means the $425 billion surplus in 2008 will decline to nearly $200 billion this year.

But it’s too early to determine the extent to which this improvement represents short-term, largely cyclical forces, rather than a more sustainable shift in savings, investment, and consumption patterns. The risk is it’s more the former than the latter, and that the bulk of the improvement in the imbalances has already occurred.

Also, in the arcane language of financial diplomacy, the meaning of “global imbalances” has been transformed. It previously was used to reference the large U.S. current account deficit, which was often cited as the biggest risk to the world economy, even as financial institutions took on leverage of historic proportions, and many of the older curbs on their conduct were either dismantled, diluted, or gamed away. In any event, the phrase is now used as a not-very-subtle reference to the undervaluation of the Chinese currency and, by extension, other developing Asian currencies, relative to major industrialized countries.

However, the increased speculation that Chinese officials will soon allow the yuan to appreciate is likely misplaced; it will probably be a second half of 2010 story at the earliest. There are a couple economic variables that might prompt Chinese officials to once again accept a yuan appreciation.

Yuan watch
First, it’s becoming clearer deflation pressures are ebbing and price pressures will increase in 2010, an understanding reflected in recent comments from Chinese officials. Although currency appreciation is a blunt tool and the emerging price pressures appear to be driven primarily by domestic forces, an increase in the yuan’s value may help curb imported inflation. As price pressures rise, even from administered prices, Chinese officials are more likely to see it in their national interest to allow the currency to appreciate.

Second, contrary to what many observers (including some in the U.S. Congress) apparently believe, China’s export prowess, which places it in competition with the U.S. and Germany as the world’s largest, isn’t simply the reflection of an undervalued currency. Surely the peg to the dollar as it has depreciated hasn’t hurt Chinese exports, but the gap between unit labor costs (a function of productivity, wages, and benefits) is significantly larger than the gap between the yuan and official measures of purchasing power parity.

Nonetheless, it seems unreasonable to expect Chinese officials to sanction currency appreciation as soon as its export shows some sign of recovery. Definitively improved export prospects appear to be a precondition for yuan appreciation. Although the monthly export average has fallen more than 20 percent from October 2008 to November 2009, exports have stabilized.

In fact, China’s export ended its 13-month decline in December 2009, increasing 17.7 percent from a year earlier. This increase can be attributed to a few factors: the slow increase of U.S. and European demand, Chinese government export facilitating incentives, and the low December 2008 base numbers. With its major markets still in gradual economic recovery, the export outlook is soft in 2010. China will seek not only to maintain its presence in U.S. and European markets, but also to increase its share in other markets for the purpose of increasing exports and diversifying its target export areas to India, Russia, and other developing countries.

In addition to monitoring inflation and exports, it’s important to watch China’s increased role in the international community. China is expanding its influence in East Asia through various trade agreements. Some state-owned enterprises (SOEs) are now allowed to use the yuan in trade settlement with certain Asian nations.

The odds are that as China receives a greater voice, it’s more likely to act as a responsible stakeholder. In this context, it’s noteworthy that Chinese economist Justin Yifu Lin was appointed World Bank Chief Economist last June. Also, Zhu Min, a vice president of the Bank of China, resigned in mid-October and become a vice governor of the People’s Bank of China (PBOC, the country’s central bank) to prepare for a senior post at the International Monetary Fund (IMF). Previously he was an economist at the World Bank. It’s not clear what IMF post Min will hold or when, but by the April IMF meeting he will have the better part of six months of seasoning, and nearly a full year by the September meeting.

International pressure is unlikely to be very helpful in signaling renewed yuan appreciation. If anything, international pressure may be counterproductive because it offends nationalist sentiment, and capitulation is seen as a sign of weakness.


For the complete article, see the April 2010 issue of Active Trader magazine. Click here to subscribe.



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