Evenett: Devaluing FX – most ‘unimaginative’ policy needed to boost exports

It’s an intriguing question, why did the People’s Bank of China devalue the currency? Most rhetoric mentions the 8.3% fall in Chinese exports in July, the largest drop in four months. So again, why devalue the currency? The theory points towards a stronger US dollar, which in turn is loosely tracked by the Chinese Renminbi, which means Chinese exports are a lot more expensive than their close rivals. And with the US expected to hike rates in the near future, this will only get worse. Hence the need to devalue the currency to boost exports. Not exactly according to Simon Evenett, he says only the most unimaginative 21st century policymaker needs to resort to crude measures to bolster exports such as currency devaluation. Simon reckons the effects of currency devaluations have nowhere near the same impact as tax breaks the government has been implementing lately. The real reason behind the devaluation – weaken the link between the Renminbi and US dollar. An interesting read. – Stuart Lowman

By Simon J. Evenett*

On Tuesday morning, just before the financial markets opened in Beijing, the People’s Bank of China, that nation‘s central bank, took steps to devalue the renminbi by 1.9%. The Chinese authorities contended that from now on market forces would have greater sway over the exchange rate, positioning this as a liberalising move.

Others, noting that Tuesday’s action was the biggest change in Chinese exchange policy since the devaluation of 1993 – a step that numerous analysts later reckoned contributed to the East Asian financial crisis of 1997 – warned that a currency war might ensue.

Why did China devalue?

China’s critics point to its falling exports – the latest data, reported last Saturday, revealed a 8.3% fall in China’s exports compared to 12 months ago – and surmise that the purpose of the currency devaluation was to help Chinese firms win orders in foreign markets and disadvantage foreigners’ seeking to sell their wares in the Middle Kingdom.

Such “competitive devaluations” have had a bad name for decades. Indeed, in the 1930s devaluations by major trading nations prompted copycat actions by others, leading to a currency war.

Brazil evoked images of the 1930s in September 2010 when it accused the US Federal Reserve Board of risking a currency war as it implemented Quantitative Easing. No wonder Beijing’s move has put many on edge.

These fears are misplaced for two reasons, the first less compelling than the second. Bear in mind that Tuesday’s devaluation of the renminbi was less than 2%.

Bloomberg’s chief Asia economist, Tom Orlik, reckons each one percent devaluation in the real (that is, price-level adjusted) Chinese exchange rate results in a one percent increase in exports after a quarter of a year. This finding implies that Tuesday’s Chinese move will reverse a fraction of its recent export contraction.

There’s an old English expression – better to get hung for a sheep than a lamb. If Beijing was going to sacrifice its reputation for international cooperation, it would probably have done so over a larger renminbi devaluation. After all, Tuesday move is hardly comparable to the Nixon Shock of 1971. Still, sceptics can argue that China’s devaluation might be followed by others.

A much-overlooked and stronger argument is that Beijing, like other governments, has other, far less newsworthy policies with which it can boost exports. Buried in national tax systems and the balance sheets of state-funded export promotion banks are all manner of ways to tilt the playing field in favour of domestic firms competing in foreign markets.

Since the crisis began China has ramped up the tax breaks it gives exporters.

So much so that a recent study by economists at a leading French research institute found that a 1% increase in certain tax rebates increased Chinese exports by 6.5%, delivering far more bang-for-the-buck than a 1% currency devaluation. That these tax rebates are product-specific means that they can be scaled up and down in response to sectoral and political needs.

The Chinese tax system already delivers an effective system of export management – Tuesday’s devaluation wasn’t necessary.

Moreover, China uses its so-called development banks to lend lots of money to foreigners to buy products made in China. Recently, the Wall Street Journal reported on a slew of deals that Chinese state banks have signed with foreign buyers – or with foreign banks that are committed to lending money to firms that want to buy Chinese products.

For sure, China isn’t alone in pursuing these policies. But the point is that only the most unimaginative 21st century policymaker needs to resort to crude measures to bolster exports such as currency devaluation.

These aren’t theoretical policy options. Two weeks before Tuesday’s currency devaluation China’s State Council issued policy directives to boost exports. Like much 21st century commercial policy, the ends were clear, the means appear to have been kept vague.

Laughing at all headlines of #CurrencyWars now. They have actually been going for a while. This #China devaluation is just the latest foray

— Mohammed Nalla (@MohammedNalla) August 12, 2015

Gentlemen don’t openly flout the conventions of the world economy. The Chinese know this as well as anyone else.

So if mercantilism wasn’t the likely rationale, what else could explain the Chinese devaluation? Let’s take the official explanation – that of allowing market forces greater sway over exchange rates.

Commitment to reform can be as fickle as young love, so the Chinese government will find it hard to convince doubters. We will have to wait for the time when currency markets push the renminbi significantly away from the level favoured by Beijing.

If the latter doesn’t fight the market’s verdict then maybe some doubters will come around. Given its track record intervening in the Chinese economy, Beijing must know that it will take years to build its credibility here – so, quite frankly, why start now?

Another potential explanation is the expectation that the US Federal Reserve Board will raise interest rates in the third quarter and the disruptive effects that this may bring. Plenty of studies have shown that rising interest rates in Washington have precipitated crises in emerging markets, whose knock-on effects can’t be reliably predicted.

Tuesday’s move effectively weakens the link between the renminbi and the US Dollar, and gives the Chinese central bank more flexibility. Preservation of options may provide the best account for Tuesday’s steps by the People’s Bank of China.

*Simon J Evenett is professor of international trade and economic development, University of St Gallen, Switzerland, co-director of Europe’s most established group of international trade economists, and coordinator of the Global Trade Alert, an independent commercial policy monitoring service.

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