FRIDAY, March 29, 2024
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China's move not aimed at igniting currency war: S&P

China's move not aimed at igniting currency war: S&P

China's surprise move to allow for more exchange rate flexibility makes good economic sense and is not the start of a currency war or an attempt to jump-start growth, said Standard & Poor's Ratings Services.

In a report titled "China's New Exchange Rate Regime Is More Structural Reform Than Competitive Devaluation ," the rating agency is of the view that the move is more likely to be due to a relatively benign "technical correction" aimed at improving market functioning or an effort to comply with the International Monetary Fund (IMF)’s conditions to get the yuan included in the special drawing rights (SDR) basket sooner rather than later.
"The argument that China is trying to spur growth by weakening its currency to spur exports does not strike us as very convincing," said Standard & Poor's chief economist for Asia-Pacific Paul Gruenwald. "Exports are more a function of foreign demand, with the exchange rate playing a secondary role. There is no reason for that relationship to have changed."
The rating agency also doubts that the move was driven by weak July trade data since these have been soft for some time - the trade surplus has been trending at a high level.
"We see the timing as opportune. This is because China can now say that by moving to a more market-determined rate it is delivering what the IMF and US Treasury have been asking for. And since the pressure is now on the yuan to weaken, having more exchange rate flexibility is palatable to the Chinese authorities," said Gruenwald.
The report notes that from a theoretical perspective, an economy cannot simultaneously have: (1) a fixed exchange rate, (2) an open capital account, and (3) an independent monetary policy with the ability to set interest rates independently from the rest of the world. As the capital account is increasingly liberalized, this trilemma implies that China's ability to enjoy (3) becomes more limited.
The IMF has also welcomed China’s foreign exchange move, saying that it should allow market forces to have a greater role in determining the exchange rate. 
“The exact impact will depend on how the new mechanism is implemented in practice. Greater exchange rate flexibility is important for China as it strives to give market-forces a decisive role in the economy and is rapidly integrating into global financial markets. We believe that China can, and should, aim to achieve an effectively floating exchange rate system within two to three years. Regarding the ongoing review of the IMF’s SDR basket, the announced change has no direct implications for the criteria used in determining the composition of the basket. Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the Renminbi were included in the currency basket going forward,” said its spokesman. 
 
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