Yuan: New kid on the forex block

If one issue dominated Chinas relations with the West, it had to be its undervalued currency, the RMB. After many pleading visits by officials from the Obama administration, the Peoples Bank of China announced last weekend to allow some flexibility in its exchange rate policy.
Western analysts believe that the Yuan is valued up to 40 percent below its fair value. Since 2008, the regime in China has all but fixed at 6.83 Yuan to the US dollar, making exports even more competitive, and naturally driving up import prices
"To be sure, the appropriate word to describe any RMB movement is gentle", said Alfred Chin at Samsung Securities in his research note released earlier this week Strategists in Asia foresee the appreciation in the Yuan to hover around 1~2.5 percent against the greenback, while the Western media claims an ascent of up to 7 percent per annum.
When the dust settles, three questions need answers from the appreciation of the Yuan.
First, the implications for the roaring Chinese economy must be considered. On the surface, the RMB will rise, goods manufactured in the country will become more expensive and purchasing power of Chinese consumers will continue to rise,
But drilling a little deeper into the risks, economists at University of California - Berkeley, who have sifted through economic performance of 27 countries after they de-pegged their currencies, offer a different view.
Their findings suggest that in view of a rising currency, economic growth is expected to slow down by 1 percent and exports are likely to decline by 5~9.5 percent. Contrary to rational expectations, in these countries imports also fell in step with exports.
Leadership in China has emphasized the need to develop a domestic consumer base. So one can, expect a lot of public spending and efforts to improve private consumption levels in the next few years, in the Asian giant.
More importantly, what is the impact of a rising Yuan on the global economy? Wall Street Journal, in the past few days ran sector specific impact assessments resulting from the regime change.
Commodities are expected to become volatile and possibly surge upwards. This is evident from the June 2005 to mid 2008 appreciation of Yuan (20 percent) against the dollar, a period which saw metal prices doubling. Remember, demand in China has been and is expected to remain firm.
China is the second largest consumer of oil. It imports around 70 percent of the crude it refines. A rising Yuan will mean cheaper oil imports domestically for the Big Red, but internationally energy prices are likely to rise as a result.
Finally, will there be any repercussions for the Pakistani economy?
According to a research note published by AKD Securities on Monday, Pakistans export competitiveness is likely to benefit in line with other developing countries. However, volatility in oil prices may neutralize any gains.
"The country is currently supporting a trade balance highly favourable towards China, where the annualized trade difference of $2.73 billion dollars is the highest amongst Pakistans trade partners", according to analysts at AKD.
Western media is celebrating Chinas decision as a triumph of diplomacy. Let it be clear that the Big Red has waved goodbye to the global financial crisis and is seeking flexibility on its currency to meet its own strategic interest, not anyone elses.