The Chinese are cautious on the yuan

Tue, 16 Mar Pre-Open

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The Chinese exchange rate has once again become a matter of contention. It is well documented that the Chinese follow an artificial exchange rate policy wherein the yuan has been pegged to the US dollar. The US has been crying foul for quite some time now. And now as the US continues to be mired in a slump, the Chinese forex policy is once again taking the centrestage.

Noted economist Nouriel Roubini is of the view that China will limit the yuan's appreciation to 4% during the next 12 months because of a 'super cautious' outlook on the global economy. According to him, this appreciation will be less than what they did in 2005 when everything was going on smoothly. To tackle the crisis, the Chinese banks have been indiscriminate in their lending especially to real estate players. Plus, the stockmarkets have also zoomed to unprecedented levels. Therefore, possible inflation in the dragon nation has emerged as a key concern. However, Roubini has pointed out that what is disconcerting is the export-led growth model, a weak currency and lower interest rates. What is more, it is not possible to change China's business model overnight and it could take 3-5 years for a meaningful change to take place.

From a Chinese point of view, the case for appreciation does not look very strong. For starters a large chunk of the country's exports is to the developed world notably the US. In the latter, consumption and demand has not really picked up as Americans are wary of loosening their purse strings given that the job scenario is shaky. This means that an appreciation of the Chinese yuan would make Chinese goods more expensive to Americans. This would then strengthen the latter's case for not consuming more. China's central bank, in the meanwhile, has stated that although such mechanism will be abandoned sooner or later, they intend to be very cautious with respect to the timing. The US, for sure, cannot expect China to bow down to its wishes anytime soon!

Indian government has been on a spending spree

There is a big difference between what happens in one year and in ten years. Take government expenditure for example. In FY11, the government's expenditure on subsidies, grants to states and union territories, grants to foreign governments, defence and pension is not expected to rise by much, But in the past ten years, these have grown in the region of 200% or more. This coupled with the stimulus measures that were injected into the Indian economy meant that the fiscal deficit will rise to 6.9% of GDP in FY10. However, in the recent Budget, the government unveiled a roadmap for reducing India's fiscal deficit over the next few years. As against an estimated figure of 6.9% and 5.5% of GDP in FY10 and FY11 respectively, the rolling targets for fiscal deficit were pegged at 4.8% and 4.1% for FY12 and FY13 respectively. What the government needs to ensure, however, is that the spending on critical sectors such as agriculture, education and healthcare does not get curtailed. But that could prove to be easier said than done.