ANALYSIS-China FX move only a minor aid to G20 rebalancing

By Reuters Staff
June 21, 2010

By Brian Love

PARIS, June 21 (Reuters) – G20 leaders are likely to remain divided over how to balance the global economy at their summit in Canada this weekend, despite China’s decision to let its currency trade more freely.

Beijing’s abolition of the yuan’s 23-month-old peg against the U.S. dollar, announced on Saturday, may partially ease tensions at the meeting by clearing the way for appreciation of the Chinese currency in the long term.

But China still seems unlikely to let the yuan appreciate nearly as fast as major trading partners would like. This means any quick, sustained reduction of the Chinese trade surplus, which was $19.5 billion in May, is probably not on the cards.

“Investors should not get carried away as China is not ready to let the yuan rise,” said Lena Komileva, London-based economist at Tullet Prebon brokerage.

“A more flexible yuan does not necessarily mean a stronger yuan against the U.S. dollar or the euro.”

And to the extent that tensions dissipate over China’s trade policy, they may become more acute in other areas, as governments focus on the different speeds at which countries are winding down fiscal stimulus for their economies.

“We can expect more sharp disagreements between the U.S. and Europe, papered over with the common call for ‘measures aimed at ensuring fiscal sustainability in a growth-enhancing way’,” said Marco Annunziata, chief economist at UniCredit bank.

CHINA

Rebalancing the global economy, by reducing dangerous differences between regions in trade flows and savings, has been a top goal of the Group of Twenty major nations since the global financial crisis of 2007-2009.

Stock markets around the world rose on Monday because China’s move on the yuan could eventually help correct a major source of trade imbalances, spreading the benefits of surging Chinese consumer demand more evenly around the world.

Annunziata described Beijing’s announcement days before the G20 summit as an “extremely clever” diplomatic ploy, because it would “wrongfoot the rest of the G20, deflating all the China-bashing enthusiasm”.

But for the foreseeable future, China appears unlikely to let the yuan <CNY=CFXS> rise much further. It stressed at the weekend that “the basis for large-scale appreciation of the RMB exchange rate does not exist”, and with Chinese labour and energy costs rising, Beijing will be reluctant to permit any currency move that could add to pressure on its exporters.

One-year non-deliverable forwards on Monday implied yuan appreciation against the dollar of under 3 percent over the next 12 months — not nearly enough, economists and businessmen say, to make a big difference to trade flows during that period.

So although G20 leaders may praise China publicly at their summit, in the hope of securing further cooperation on exchange rates, they are unlikely in private to obtain any commitment to an extended, sharp appreciation of the yuan.

AUSTERITY

Meanwhile, tensions over austerity measures in G20 countries may increase. After last month’s costly bailout of Greece, Germany has been pushing for the rest of the euro zone to implement deep public spending cuts to bring their budget deficits under control and reassure the bond markets.

Washington worries that Germany is slamming its foot too hard on the brakes, which could potentially push Europe back into recession and hurt the global economic recovery. In a letter released last week, U.S. President Barack Obama said public finance problems should be addressed in the medium term — implying they should not be the focus now.

Obama also said he was concerned to see some countries with large trade surpluses relying too much on exports and too little on domestic consumption — another apparent reference to Germany, which has been criticised for not doing enough to import goods from weak south European economies.

German Chancellor Angela Merkel flatly rebuffed Obama on Saturday, saying Europe would push for a swift exit from fiscal stimulus programmes and a focus on budget consolidation at the G20 summit.

“European participants are of the opinion that this is urgently necessary to prevent such crises from happening again in the future,” she said.

The relatively loose U.S. approach to fiscal policy may also come in for criticism once again from China, which is heavily exposed to market jitters about U.S. government finances because of its big investment in U.S. Treasuries.

G20 FRAMEWORK

At a meeting in Scotland last November, G20 finance ministers and central bankers laid out a timeline for the group to work towards rebalancing the global economy.

At this year’s June summit, G20 leaders were to discuss and agree on “a basket of policy options”, which would be prepared with the help of the International Monetary Fund, the World Bank and other international organisations.

Leaders are not expected this weekend to agree on any fresh measures that countries would take, however. What is likely to materialise in Canada at best is a list of economic reforms that each country in the G20 is pursuing, said an official source involved in preparations for the summit.

This list, which would include structural reforms such as changes to pension or labour market rules, will help countries discuss the impact of their actions on the global economy, said the source, speaking on condition of anonymity.

But it is not certain that the leaders will make the list public, because China and Saudi Arabia among others do not want to become subject to public peer pressure, the source said, adding that there were “low expectations” for the meeting.

Under the G20′s timeline, the group’s leaders will discuss and agree on more specific policy recommendations at a summit in November this year.

(Editing by Andrew Torchia) ((brian.love@reuters.com; +33 1 49495339; Reuters Messaging brian.love@reuters.com@reuters.net))

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