A Mahatma and a Mao in your pocket

(This column was published in DNA edition dated April 28, 2010.)

Venky Vembu

Barely two weeks from now, perhaps the biggest, most significant, economic news story of this year will begin to unfold. In the way it plays out, it might appear mind-numbingly ‘unsexy’: compared to the adrenaline rush of the recent IPL series (or the crorepati wheeling-dealing), it will seem as exciting as watching grass grow in slow-mo. But don’t mistake placidity for ineffectualness: the upcoming mega-event has already triggered a global stampeding of moneybags, some of which could find their way to India. It opens up a range of challenges for policymakers, but also opportunities that savvy investors can profit from.

The ‘event’ is, of course, the breathlessly anticipated ‘de-pegging’ of the Chinese renminbi (yuan) from the US dollar. To understand its significance, a bit of historical perspective is useful. China, the world’s third largest economy, has built up its export muscle over the years by keeping its currency artificially low. And although it effectively de-pegged the yuan from the dollar in 2005, and allowed its currency to appreciate by about 20% over three years, it reverted to the dollar peg in 2008, when the global financial crisis caused its export economy to collapse.

That knee-jerk, survivalist response had a knock-on effect on other low-wage economies, including India. It rendered their exports less competitive; it also cramped the policymaking space for inflation-battling central bankers by forcing them to resort to a partial peg of their currencies – or see a sharper fall in exports and a flood of potentially ruinous ‘hot money’ inflows. 

More critically, at a time when consumer spending in developed economies is down and out, China’s dollar-peg drew criticism for accentuating global trade imbalances by sending out into the world even more finished goods. Additionally, its pegged currency smothered domestic Chinese consumption, by effectively ‘transferring wealth’ from Chinese households to exporters.

After much badgering – from the US – and some mild-mannered cajoling – by others, including India – the yuan is likely to be de-pegged, perhaps in the second week of May. Nobody expects a dramatic revaluation: the consensus among economists is that the yuan might appreciate by 4-5% this year. But even that, and the prospect of greater appreciation over time, could reverse some of the negative influences of a pegged yuan.

First, it could render Indian exports, particularly at the low-value end, marginally more competitive, which should help improve India’s trade balance. Second, it would give the RBI a bit of elbow room in its effort to combat inflation without rising growth-sapping interest rates again. A moderate rupee appreciation, combined with India’s high-orbit economic growth, could be a magnet for higher portfolio inflows into Indian stock and real estate markets, although they come with the risk of feeding bubbles. Each of these possibilities offers opportunities for savvy investors.

A stronger yuan would also ‘enrich’ domestic Chinese consumers and companies, and make overseas acquisitions relatively cheap, so expect to see a rash of hysterical reports about how Chinese are “buying up the world”. One downside is that given China’s ravenous appetite, commodity prices could spike, with inflationary impact.

The yuan is, of course, not a freely convertible currency, and reports last year that it would rapidly emerge as a global reserve currency have proven to be greatly exaggerated. Nevertheless, the trend towards a gradual internationalisation of the yuan is unmistakable; starting mid-May, Indian travellers to China can purchase yuan-denominated travellers’ cheques. It will still be a while before Mao Zedong nestles alongside Mahatma Gandhi in your wallets, but next month’s ‘big event’ could be a milestone towards that.

Advertisements

About Venky

Journalist, blogger, amused observer of worldly goings-on... More about me here.
This entry was posted in China, Columns, Economy, India and tagged , , , , , , . Bookmark the permalink.

2 Responses to A Mahatma and a Mao in your pocket

  1. Pingback: ‘China’s economy is dangerously addicted to cheap money’ | It's only words…

  2. Pingback: The dollar may be down, but it’s far from snuffed out | Firstpost

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s