China and the renminbi matures

Originally published in Bloomberg View on 18/4/14. Reprinted with permission. The opinions expressed are those of the author.

China’s central bank has announced a widening of the trading band of the renminbi from a daily maximum of 1 percent to 2 percent. The move follows a recent increase in the currency’s volatility, and the apparent end of its long, slow rise against the dollar. What does the new policy mean?

Some will say, not much. The People’s Bank of China, on one view, is merely responding to market forces. The sudden downward pressure on the currency merely reflects a new reality, in which China faces economic challenges and its growth slows as a result. Perhaps officials welcome the depreciation because it will help to stimulate the economy. In any event, it’s an essentially passive response to events they can’t control.

There’s more to it than that. Chinese policy makers have been telling the markets for some time that they’re going to let the renminbi fluctuate more freely. They’ve also been more forthcoming about their assessment of the currency in relation to its fair or equilibrium value. These statements suggest that the move to a wider band is part of a longer-term vision — a reading that’s consistent with other recent policy developments, including efforts to reform the domestic interest rate markets.

I’d put it this way: In economic terms, China is becoming more of an adult, and the renminbi is becoming a grown-up currency.

As a more normal major currency, the renminbi will go up and down, and its movements, especially on a daily basis, will become less predictable. There’ll be dramas now and then. The currency is still in transition, and experience suggests that the markets may test how far the central bank is in control by pushing the renminbi toward its new lower bounds. Sure, that could happen — but it’s the direction of the reform that matters.

I’ve noticed I’m often more impressed than the average observer by China’s policy making. This is no exception. The timing of this move is astute. The economic fundamentals driving exchange rates make it increasingly clear that the renminbi is no longer undervalued. Indeed, the latest monthly trade figures reported a large deficit. The Chinese New Year probably distorted those numbers, but the longer-term trend points the same way.

In 2013, China’s current-account surplus fell to less than 3 percent of gross domestic product; before the global credit crisis of 2008, the surplus was running at more than 10 percent of GDP. This year, the surplus will probably fall again, to less than 2 percent of GDP. Whatever else happens, politicians in the U.S. and elsewhere can no longer accuse China of keeping its currency unfairly cheap.

Many observers have noticed China’s weaker export performance — one cause of the smaller surplus. But the rise in Chinese imports gets less attention. In a new paper for Bruegel, a European think tank, Alessio Terzi and I discuss world trade (which is changing rapidly) and global governance (which isn’t). The paper emphasizes that China’s role as an importer is on the rise. Already, its share of global imports, at roughly 10 percent, is not far short of the U.S. share. The latest data strengthen my belief that by the end of 2015, China may well be the world’s biggest importer of goods and services.

China has successfully moved toward more balanced trade while managing its currency more closely than many would have liked. That ought to command some respect — and the same goes, if you ask me, for the thinking of the Chinese leadership on the pace of reform in domestic finance, and on whether and when the renminbi should be granted a bigger role in global finance. We’ll probably hear more from China on that second issue soon. I think it’s time for the International Monetary Fund to consider including the renminbi as part of the Special Drawing Rights basket. (An updated assessment of the SDR’s role is due by the end of 2015.)

Why not go further? Russia’s actions in Ukraine have prompted the idea that it should be kicked out of the Group of Eight. Maybe that place should be offered to China instead.