Tuesday, May 24, 2005

WSJ : China Is Considering A Currency Basket As Option for Yuan

May 23, 2005; Page C1

BEIJING -- Even as China has fended off demands to revamp its currency system, its central bankers have fanned out around the world to solicit advice on the matter. They are paying close attention to Singapore's unusual setup.

International pressure on China to change its exchange-rate system has accelerated in recent months, partly because of the country's surging exports and economic growth. U.S. and European critics say Chinese products are unfairly inexpensive, because the yuan has effectively been pegged to the U.S. dollar for more than a decade and now is undervalued. Last week, Treasury Secretary John Snow appointed a special envoy to China to "continue and intensify a constructive dialogue with China" on exchange-rate and other issues.

Beijing has said little more than that it is studying a change. "So long as conditions permit, China will push reform of the exchange rate on its own initiative, even without outside pressure," Premier Wen Jiabao said at a forum in Beijing last week.

China's central bank is examining a range of options, from expanding the yuan's trading range beyond its current 8.28 to the dollar, to taking a more complex and creative approach, according to people knowledgeable about its thinking.

The People's Bank of China has sought advice from private-sector banks, consultants and a number of central banks, including the Hong Kong Monetary Authority, the Monetary Authority of Singapore and the U.S. Federal Reserve, as well as from the International Monetary Fund.

Lately, China's central bank has given special attention to how Singapore deals with its currency, the Singaporean dollar, says a banker advising the central bank. Implemented in 1981, Singapore's currency regime is a "managed float" -- a compromise between China's effective peg, set by its government, and the U.S. approach, in which the dollar "floats," its value determined by market forces.
Singapore pegs its dollar to a basket of currencies that mirror the city-state's trading patterns. Its central bank, the Monetary Authority of Singapore, doesn't announce what is in the basket; the authority's bankers just tweak the mix as needed, depending on how Singapore's trade flows change.

Some economists say such an approach could prove to be a neat compromise, enabling China to say it has moved to a more flexible regime without opening the floodgates to volatile capital flows.

The system has worked well for Singapore, which is about three times the size of Washington, D.C., and has a gross domestic product that is roughly half of Wal-Mart Stores Inc.'s annual revenue. From 1981 to the present, income per person in Singapore has risen sharply, inflation has remained contained and interest rates have stayed low, encouraging consumers to spend. Despite essentially open borders for goods and capital -- a chief reason Singapore needed a tool like the basket, since it can't control its own interest rates -- the Monetary Authority of Singapore has managed to keep the Singapore dollar relatively stable while it slowly trends upward.

China's exchange rate isn't whipped around by the gobs of capital pouring into its country, either, but that is because its central bank keeps the currency fixed by buying many of the dollars that flood into the country. The result has been a massive buildup of foreign-exchange reserves. Many economists agree that while China can easily afford to do this today, eventually it will become too expensive an exercise. Almost all agree that if China were to move to a basket or a type of floating regime today, like Singapore's, the yuan would steadily strengthen.

"Moving to a basket makes sense," says Nicholas Lardy, an economist at the Institute for International Economics, a Washington think tank, and a longtime advocate of such a move.

Some economists worry that a basket would increase volatility in China's exchange rate, creating new problems for the country's corporations, which have little experience managing exchange-rate risk. Singapore also can steer its economy through a variety of unofficial policy measures, a task that would be much more difficult in a country the size of China.

--James T. Areddy in Shanghai contributed to this article.


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