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Op-ed

The Renminbi: The Panda in the Room

by Arvind Subramanian, Peterson Institute for International Economics

Op-ed in the Business Standard, New Delhi
December 28, 2007

© Business Standard


India should work towards new WTO rules on undervalued exchange rates.

Let’s face it. The relentless rise of the rupee is a problem in itself but especially so because China has managed to keep the renminbi undervalued for some time now. Rupee appreciation—in the face of renminbi fixity—entails a loss of competitiveness for India vis-à-vis China and East Asia and with it some loss of economic growth. The Chinese currency is the elephant, or rather panda, in the room. It is time to deal with the panda.

The extent of undervaluation of the renminbi is subject to debate, but my Peterson Institute colleagues, Morris Goldstein and Nick Lardy (see "China's Exchange Rate Policy: An Overview of Some Key Issues" [pdf]), are not outliers amongst the China-watching pack with their assessment that the renminbi is undervalued by about 30 to 40 percent.

A very rough back-of-the-envelope calculation of the effect on India of this undervaluation is the following. China and other East Asian countries, including Japan, have a weight of about 25 to 30 percent in the Indian trade basket. True competitiveness depends not just on actual trade but also potential trade, i.e., markets where these countries and India are potential competitors. A ballpark figure would suggest that these countries account for roughly one-third of Indian competitiveness. Now, if China’s undervaluation were eliminated, the resulting appreciation of the renminbi and with it other East Asian currencies would lead to a de facto rupee depreciation of about 10 percent. This is broadly the loss in competitiveness that India has suffered this year and that has caused such angst in the country.

Suppose that India considered these costs important enough to take action. What could it do? So far, Indian policymakers and business have maintained a studious public silence, reflecting perhaps impotence: What good can come of griping when India’s ability to influence Chinese policy must be pretty close to zero? How can India succeed when the collective efforts of the United States and the European Union have failed? But is this helplessness and the consequential inaction warranted?

The key is to recognize that the Chinese exchange rate has become a systemic issue, affecting not just the United States and the European Union—which have long railed against China with little effect—but countries around the world. India should therefore strive toward a collective multilateral response to the Chinese exchange rate problem.

This multilateral response can either be in the International Monetary Fund (IMF) or in the World Trade Organization (WTO). The problem with the former approach is that the IMF has increasingly come to be seen by East Asians and developing countries in general as having a legitimacy deficit because its governance structures reflect the receded realities of an Atlantic-centered 1945 rather than those of an ascendant Asia of the 21st century. Asian and Chinese grievances directed at the refusal of the Atlantic powers to share power are not very different from India’s. From India’s perspective, the costs of cooperating with the United States and Europe on China’s exchange rate in the IMF may be too high in terms of fracturing the developing country solidarity necessary to reshape the international economic landscape and institutions.

Fortunately, there is an alternative. India could work toward multilateralizing the exchange rate issue. And here’s the punch line: This multilateralization should be in the context of the WTO rather than the IMF. In a new paper, Aaditya Mattoo of the World Bank and I offer suggestions on how the exchange rate can be made into a multilateral trade issue. The WTO is the obvious alternative to the IMF since undervalued exchange rates have large and direct trade consequences. What is needed is a new rule in the WTO proscribing undervalued exchange rates, which are in effect a combination of export subsidies and tariffs, each of which is currently disciplined by the WTO. The WTO is also a more appropriate forum because it is less plagued than the IMF by perceptions of eroding legitimacy.

The WTO, for all its flaws, is less asymmetric in the distribution of its powers between the rich countries and emerging market economies than are the Bretton Woods institutions. In the latter, this distribution of powers was historically determined and has proved immutable, especially since the currently powerful have been reluctant to cede power. In the WTO, powers and influence evolve organically because they flow from market size. As China, India, and Brazil have grown rapidly, they have naturally, and without any help from other countries, become more serious players in the trading system. They have commanded power. They have not needed it to be conceded.

For this important reason, if China will be at all receptive to discussing their exchange rate in a collective context, it is more likely to be in the WTO than in the IMF. So, when countries get together to revive Doha, India should instigate efforts to put undervalued exchange rates on the trade negotiating agenda. Of course, these efforts will find a receptive audience in Washington and Brussels. That goes without saying. But India should not be surprised if enthusiasm is even greater in Brasilia, Mexico City, Seoul, Kuala Lumpur, and other Asian neighbors. In other words, almost all the world has felt the impact of a hypercompetitive renminbi but has been too diffident to raise it individually or collectively.

Interestingly, Mr. Chidambaram may have fired the first developing country salvo when he recently called for greater flexibility of the Chinese exchange rate at the World Economic Summit in Delhi. The government needs to follow up by mobilizing the various constituencies within India and governments abroad to muster the collective action that will be necessary to address this issue.

The exchange rate and the associated “impossible trinity” have been the policy obsession of the year in India. But if China were to reduce or eliminate its currency undervaluation that would help address, at least partially and for the present, this trinity. And in the process it might even—dare we say it—unite the other incompatible trinity in India: the Ministry of Finance, the Reserve Bank of India, and the Ministry of Commerce. Now, how many policy initiatives can accomplish that?


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