IMF gives ground on yuan exchange rate debate

The International Monetary Fund has chosen not to call the yuan “substantially” undervalued, a move that recognises China’s efforts to free up its exchange rate and avoids friction with an increasingly influential shareholder.

The summary of an annual review of China’s policies omitted the contentious word, used by IMF Managing Director Dominique Strauss-Kahn as recently as June, which has long riled Beijing.

Several members of the IMF’s 24-member executive board believed the Chinese currency was too cheap, the fund said.

But others said a structural reduction in the balance of payments surplus was already unfolding thanks to past steps to boost consumption, while others took issue with an assessment by IMF staffers that the yuan was substantially undervalued.

“This does reflect a softening in the board’s position about the degree of adjustment that is needed in the Chinese exchange rate regime,” said Eswar Prasad, a senior fellow at the Washington-based Brookings Institution and a former IMF official.

He said this was reflected in statements to the IMF board, that China had already made a big move towards greater currency flexibility and progress in rebalancing demand.

Beijing dropped the yuan’s 23-month-old peg to the dollar and reverted to a managed float on June 19. China’s trade surplus has also shrunk considerably as government efforts to pump up the economy have sucked in imports of commodities and capital goods.

“On both counts this conciliatory tone is a little premature, because despite the announcement there hasn’t been that much movement of the Chinese currency. Any notion that they have in fact successfully started rebalancing their economy is also quite premature,” Prasad said.

Staff still undervalued
The yuan has risen 0.7 percent against the dollar since it was unshackled from the US currency.

Prasad said IMF economists reckoned the yuan was still between five percent and 27 percent undervalued depending on the methodologies used. A diplomat in Beijing confirmed the range.

“Several directors agreed that the exchange rate is undervalued. However, a number of others disagreed with the staff’s assessment of the level of the exchange rate, noting that it is based on uncertain forecasts of the current account surplus,” the IMF said.

Prasad said IMF economists are projecting a big rebound in the current account surplus, which has fallen to around four percent of GDP, whereas China is contending that it will stay at the new, lower level.

People familiar with the board’s deliberations said representatives of the Group of Seven rich nations supported the IMF staff’s conclusions but did not specifically call the yuan “substantially” undervalued.

Reflecting the discussion, the board’s concluding statement omitted the disputed phrase.

China was so angry with the fund’s exchange rate views that it withheld cooperation on the annual review from 2007 to 2009.

Beijing, though, has gradually been gaining clout in the IMF. Last year it bought $50bn worth of notes to beef up the fund’s capital and a deputy governor of China’s central bank, Zhu Min, has started work as a special assistant to Strauss-Kahn.

Resource shift
The IMF’s choice of words is the second qualified recognition in July of the progress China is making in liberalising its exchange rate.

On July 8, the administration of President Obama said the yuan remained undervalued but declined to designate China a currency manipulator.

That finding angered US lawmakers, many of whom argue that China is unfairly holding down its currency to favour its exporters and are threatening punitive action.

But a Chinese academic rejected US criticism and said the yuan, also known as the renminbi, was not too cheap.

“The US trade deficit with China has nothing to do with the yuan’s exchange rate,” He Weiwen, a professor at the University of International Business and Economics, wrote in the People’s Daily.

The IMF said the scrapping of the dollar peg would increase the central bank’s flexibility to tighten monetary conditions.

A stronger yuan rate would also be good for the rebalancing of the domestic and global economies by shifting China’s growth from exports and investment to private consumption, it said.

On other issues, the board supported a gradual phase-out of China’s massive fiscal stimulus in 2011, provided the current trajectory for the economy – the IMF expects continued robust growth with benign inflation – is maintained.

Directors commended the slower pace of money growth that China is targeting this year but urged it to raise interest rates. Unlike many other Asian countries, including India, China has not increased borrowing costs in 2010.