TCS Daily


China's -- and Asia's -- Great Leap Forward

By Rowan Callick - July 27, 2005 12:00 AM

New York Senator Charles Schumer describes China's July 21 "dirty float" - the shift of the decade long alignment to the greenback of its currency, the yuan, to a secret "basket" of currencies - as "a good first step, albeit a baby step."

Its initial impact is modest, allowing the yuan to appreciate 2.1 per cent against the $US. But as Li Yang, a senior economist with the Chinese Academy of Social Sciences, comments: "The most important thing is the change, not how much it changed."

Further appreciation is almost certain to follow. And while Sen. Schumer - the co-sponsor of a proposal to impose a 27.5 per cent duty on Chinese imports - is right that this first move is a "baby step" for China, the jump from the $US comprises a giant leap for Asia's economic autonomy.

Since World War II the international economy has turned around the United States. But the last three years have seen the creation of a second great global trading hub in Asia, centred on China.

Now, the sheer weight of money - two thirds of the world's foreign exchange holdings are owned by Asian countries - has liberated China, and by extension most of its neighbours, to take a symbolic but significant step towards an Asian currency network that will act independently of the greenback.

This seismic economic shift will gain political expression through the East Asian Summit in Kuala Lumpur in December that will be attended by the leaders of the ten countries of the Association of South East Asian Nations, and by China, Japan, South Korea, India, New Zealand, and almost certainly Australia.

The summit is expected to lay the foundations for the emergence of an Asian economic community - which will be accelerated if the World Trade Organisation's Doha round fails to move forward significantly at the ministerial meeting in Hong Kong, also in December.

Richard Martin, managing director of Sydney based business analyst IMA Asia, says of Beijing's move from the $US peg: "This is the first major currency re-alignment controlled by Asia, not by the central banks of the US or Europe. That's because Asia has the money." The top eight foreign exchange owners in the world are, in order: Japan, China, Taiwan, South Korea, India, Hong Kong, Singapore and Malaysia.

"Once you have the money," says Martin, "you make the decision. The euro and the $US have swung wildly in the last two years, and everyone has been waiting for the whole process to settle down. That wouldn't happen until Asia stepped forward with its own decision. From now forward, moves within Asia will have a major impact on world currency markets, because of their scale. And they will make those moves in lockstep."

Informally, the region already has a shared production platform, with many components today assembled in China, sending intra-Asian trade soaring from 38 per cent of the total in 2000, to more than half last year, according to Citigroup.

Formally, the Asian central banks have been working hard since the regional collapse of 1997, the single event that did most to trigger Asia's current resurgence, to communicate better, and to coordinate more. They hold regular meetings, they have agreed to support each others' currencies if they come under attack from hedge funds or other threats, and they are together creating Asian currency bond markets.

Bank Negara Malaysia, the country's central bank, shifted the ringgit from a $US peg to a basket of currencies within an hour of Beijing's move, clearly because of close, regular contact between Malaysia's and China's economic managers.

Singapore based UBS analyst Bhanu Baweja says that even before China de-pegged the yuan, expectations of such a shift "acted as a strong anchor for Asian currency moves," so that the correlation between Asian currencies has become stronger with the yuan than with the Japanese yen. Now, he says, the Asia/$US correlation will diminish too.

Gross domestic product in Asia, outside Japan, is expected to grow 6.2 per cent in 2005 and 6.5 per cent next year, compared with 3.7 per cent and 3.5 per cent for the US and 1.3 per cent and 1.8 per cent for the euro area. And Japan is forecast to comfortably exceed European growth, rising 1.6 per cent this year and 2.1 per cent next. Domestic demand is playing a big role in driving this Asian growth, especially in Japan, China and India - in turn boosting already strong intra-regional trade from the export manufacturing driven economies of countries including South Korea, Taiwan and Singapore.

The steady rise in currencies around the region which is already under way, triggered by China's move, will cushion the impact on their GDP growth of continuing oil price rises.

Jonathan Anderson, UBS' chief economist Asia, says that while protectionist pressures in the US helped influence the timing of the move, "we certainly don't see the Chinese as 'bowing' to US demands. A renminbi adjustment is clearly in China's own long-term interests, and the government has been preparing this move for at least two years." He said: "There are very few industries indeed where US and Chinese workers compete head-to-head, which makes the impact on the US economy much less than the impact on China's Asian neighbours."

The rise in currencies around the region is already boosting expectations of an increase in demand for Asian assets, accelerating the flow of portfolio funds and foreign direct investment, and building even bigger international reserves in Asia, says ANZ Bank senior economist international Amy Auster. The Thai and Indonesian currencies have been especially weak, but both central banks had been reluctant to raise interest rates because of incipient inflation. Now the Chinese appreciation is handily dragging the Thai baht and the Indonesian rupiah up too.

The appreciation of the yuan - likely to continue, within the bounds of the extended trading band - will also fuel China's growing appetite for international mergers and acquisitions, especially in the resources industry. And broadly rising Asian currencies will benefit international corporations with a regional presence, such as retailer McDonald's and finance houses HSBC and Standard Chartered, and Australia's Macquarie.

John Snow, the US Treasury Secretary, underlined the broader significance of the move, saying that Chinese currency reform was "important for China and the international finance system." This indicates just how far and fast the world's economy has shifted towards China and Asia. Even just a dozen years ago, it would have caused little interest beyond Beijing, let alone dominated the world's financial news.

Rowan Callick is Asia-Pacific editor of The Australian Financial Review.

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