People’s Bank of China governor Zhou Xiaochuan last night rejected calls for China to liberalize its foreign exchange rate regime more quickly, as a means to spur domestic financial reforms and prevent the Chinese economy from overheating.
In an exclusive interview with Emerging Markets Zhou said it is by no means certain that liberalization would have the generally expected effect of boosting the value of the yuan.
Arguments have been made at the annual meetings, including by US Treasury secretary Henry Paulson, that it would be in China’s interest to free up its foreign exchange regime sooner rather than later, and that this would help to bring about an orderly unwinding of global financial imbalances.
In an interview with Emerging Markets US Treasury undersecretary Tim Adams said: “The problem China faces is they’re not putting in place fast enough market-based tools to deal with an increasingly market-based economy.”
Adams, who is due to accompany Paulson to China later this week for two days of talks, said: “There is an arising risk that China moves too slowly and therefore that poses a real risk to the global economic community.”
But Zhou implicitly challenged both arguments. “Actually, we are not very sure whether liberalization of the exchange rate would necessarily mean the revaluation of the RMB,” he said. “We still have restrictions on capital account. A lot of Chinese citizens and companies want to invest overseas [but there are] restrictions under the Foreign Exchange Act on remittances overseas.”
Reform of the present foreign exchange rate regime would means that “on one hand we would have a current account surplus, but on the other hand, on the capital account, more Chinese people [would want] to buy foreign exchange to invest overseas and to go abroad as tourists.” This makes the impact on the yuan difficult to predict, Zhou argued.
At the same time, he rejected the idea that a more open foreign exchange rate regime would spur more rapid domestic reforms in China. “Basically, we do not like that kind of idea,” Zhou said. “It is part of Chinese philosophy [that] we need to let our economy adjust gradually to the new [liberalized exchange rate] system,” he said.
“Before we liberalize our foreign exchange regime, we need also banking sector reform, the liberalization of interest rates and also reform of the Chinese financial markets,” he said. “We have not yet completed all these reforms and in this regard, we think that reform of the exchange rate should be gradual.”
Zhou acknowledged that there could be circumstances in which China might have to liberalize the rate more rapidly. “If there is any sudden change and any big crisis, then we would have to use relatively radical policy changes to deal with it,” he said. “But recently there has been a relatively peaceful environment,” he added.
China has a “relatively good macroeconomic situation, with a relatively high growth rate and low inflation,” he noted, citing the fact that consumer price inflation has been running at an annualized rate of only 1.2% in the first half of this year. Zhou said he did not accept claims that China’s economy is overheating, and that a stronger yuan is needed to help cool the economy and to take the pressure off domestic interest rates.
“We do not actually know the growth potential of the Chinese economy,” Zhou said. “An 11% growth rate seems very high but China’s savings rate is very high, and corporate profits recently have been very good. International conditions are also good. Demand from the US, Europe and recently Japan is strong.” All these factors come together, making it difficult to judge whether the economy is overheating.
Zhou challenged arguments that China’s contribution to unwinding global imbalances should be revaluation of the yuan. “No single party can find a solution” to the imbalances.
“Now there are multilateral consultations on the global imbalances, and it is a good sign that each party is starting to realize that they can do something about the situation. These consultations are still going on, and there is not yet any consensus. But the process is good, because policy directions are being set.”