The modest revaluation of Chinese renminbi is a widely expected surprise. It had to happen sooner or later. It has not only happened but it has also given enough scope for expectations that the renminbi might strengthen further.
Revaluation of barely 2.1 per cent is hardly an earth shattering development. Its significance lies in the fact that it signifies the end of an 11-year peg with the US dollar at 8.28 and introduction of a managed float.
The renminbi, at 8.11 to a US dollar now, will be allowed to move in a narrow band of 0.3 per cent against the US dollar in daily trading and 1.5 per cent against an unspecified basket of currencies. Such "snake in the tunnel" experiments have failed spectacularly in the past.
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There is near unanimity amongst the analysts that the extent of revaluation is too modest and that the Chinese currency is still overvalued. Naturally, speculators will see a managed float as an invitation to pump in money into China and pull it out at a more favourable time.
However, the People's Bank of China has enough reserves ($711 billion) to intervene in the markets and sterilise the speculative flows. How the People's Bank will use its clout is a mater of sufficient concern to China's competitors.
The neighbouring Asian countries have reacted rather positively to the revaluation of the renminbi. Currencies have appreciated across Asia and the stock markets shot up to celebrate the revaluation. Yet, it is too early to predict the way forward.
What is the composition of the basket of currencies? How regularly the People's Bank will adjust the value of the currency in future? What would prompt decisions to change parity levels? There are no immediate answers to these questions.
At the political level, the revaluation might help tone down the intensity of demand for action against China in Europe and the US. The Chinese leadership might be seen as more responsive to what its major trading partners say.
Yet, it is too premature to dismiss it as a mere political move. The revaluation does signify a significant policy shift.
In theory, the revaluation ought to make Chinese exports relatively expensive. The exports and, consequently, the GDP growth should slow down and imports should increase. However, this might not happen, at least immediately, given the modest scale of revaluation. Moreover, competitiveness is not determined solely by exchange rates.
In terms of impact on the market sentiments, measures like the revaluation of renminbi, indications that the Chinese leadership is more inclined to behave as a responsible economic power and expectations that China will move towards a market-determined exchange rates are very significant. As a consequence, China may see a further boost in foreign direct investment.
Many analysts see the revaluation as a response to high growth levels and significant trade surpluses in China. There is near unanimity that the long overdue reforms in the financial sector will now be difficult to avoid.
Yet, few agree on the extent of the cooling effect that the revaluation might have on the growth rates and when the Chinese leadership will act decisively to reform its financial sector.
In India, some entertain fears about the impact of the Chinese revaluation despite their implicit faith that the Reserve Bank is equal to the challenging task of maintaining price levels, exchange rate stability and growth momentum.
