Can China Avoid Devaluing Yuan?

First they went on a government spending spree worth billions of dollars. Then they cut interest rates seven times in three years. They’ve also loosened consumer credit; pumped up the stock market; boosted lending; and even proposed a tax on personal savings to get people to spend money, not hoard it.

But in spite of pushing almost every lever at their disposal, the leaders of China--once a dynamo of double-digit economic growth--have failed to arrest the country’s deflationary spiral: declining prices, declining demand and declining consumer confidence.

Now analysts warn that China may soon find itself staring at the final item on its nearly exhausted list of options: devaluing the yuan.

It’s a drastic measure that leaders have assiduously avoided, for good reason. Devaluation would send shock waves through the rest of Asia just as countries rocked by the region’s financial crisis are beginning to recover. And Beijing is obsessed with maintaining domestic stability in the run-up to its big Oct. 1 celebrations of the 50th anniversary of the founding of Communist China.

So to further forestall such a step, Beijing has a few more tricks up its increasingly threadbare sleeve.

When the country’s top officials gathered this month for their annual strategic retreat at the seaside resort of Beidaihe, devaluation was apparently not on the agenda--only some new measures to resuscitate debt-ridden state-owned enterprises.

To get residents to spend more, the government has promised to raise the wages of civil servants by more than a third and to increase compensation for laid-off workers and low-paid urbanites. On a macro level, the central bank is also expected to act to boost China’s money supply.

Experts say it’s most likely China will wait to see if these latest policy initiatives have any effect before it devalues its currency.

But time is running out for people like Shi Feng, who runs an export-import company based in the bustling southern city of Guangzhou. Partly because of the yuan’s strength against other Asian currencies, exports have dropped in the last year, posting a decline of 4.6% for the first half of 1999. And the country’s trade surplus has diminished by two-thirds in the same period, to $8 billion.

“Last year was bad, and this year is even worse. Business has dropped at least 30% at our company,” said Shi, 33. “And it seems to me that so far the government hasn’t come up with a way out.”

The latest measures unveiled by the Beijing regime feel to many like a close-to-last-gasp effort.

“What we’ve seen so far is basically fiscal spending--the government issuing 300 billion [yuan] in bonds and using the money to invest in bridges and toll roads,” said Qu Hongbin, a consultant for the Bank of China. “What we haven’t seen is the government boosting money supply. Monetary expansion hasn’t been aggressive enough.”

Qu is optimistic that the new measures will stimulate domestic demand for products such as TV sets, which state-owned enterprises keep churning out but which have been gathering dust on store shelves and in warehouses across the country.

Putting more money in people’s pockets, however, is no guarantee that they’ll spend it. The extraordinary saving habits of the Chinese--the population boasts of one of the highest personal-savings rates in the world--continue to keep consumers out of the stores. About 42% of urban household income gets socked away. Not even repeated cuts in interest rates, to a current 2.25%, have persuaded consumers to part with their money. The latest government scheme to discourage hoarding is rumored to be a 20% tax on interest earnings.

“There are price wars everywhere for clothes, electric appliances, furniture and so on,” said Liu Gong, 40, who works for a state-owned company. “But these are all consumer goods; they’re not necessities. . . . We’re not rich enough or secure enough to be consumers.”

Beijing has also eased taxes on stock trading to pump up action in China’s two bourses, in Shanghai and Shenzhen. In an astonishing show of capitalistic fervor from a regime committed to austere Maoism just 20 years ago, the Communist government used its flagship newspaper, the People’s Daily, to give the stock market its official blessing and to encourage comrades to buy, buy, buy. The market, said a commentary on June 15, had delivered “happiness and hope” to the masses.

The campaign has been “shameless, but effective,” the Economic Intelligence Unit consultancy reported last month. Within two weeks of the editorial, China’s stock exchange indices shot up by as much as 30%.

But there is plenty of skepticism that the new reflationary measures will have much of an impact, which is prompting some economists to forecast that China will resort to a devaluation early next year.

The head of the central bank, Dai Xianglong, caused a furor in July when he said that the yuan’s value, which is unofficially pegged to the dollar, would be determined by market forces--an apparent backing away from his earlier pledges that the currency’s value would remain fixed.

Throughout the last year, rumors of a yuan devaluation have flitted through Asian markets like ghosts through a haunted house. But like ghosts, they have not materialized.

During the region’s 1997-98 economic meltdown, China’s leaders scored major political points in the international community for holding the yuan steady--at about 8.3 to the dollar--even as other Asian countries let their currencies plunge. But China’s exporters, and the economy, paid a steep price.

The time for such teeth-gritting endurance may be nearing an end, analysts say. “They feel like they have already sacrificed a lot in terms of exports,” said Sherry Liu, director of investments for Credit Lyonnais Securities Asia.

A cheaper yuan would make China’s products less expensive overseas, thus boosting exports. And it might be less damaging to other Asian economies, because they have since gained strength, than it would have been a year ago.

But economists caution that devaluation would be no magic bullet.

The cost of producing items for export would be driven higher because any foreign components going into them would become more expensive. Moreover, Chinese debt denominated in other currencies would cost more to repay.

It is still possible to avoid a devaluation, analysts say. They note that demand from other Asian nations is picking up as countries such as South Korea and Thailand slowly rebound from financial near-collapse.

In July, the government reported this week, China’s exports actually rose 7.5% on the back of rising Asian demand and fresh export subsidies. Also, Beijing maintains a high level of foreign reserves, about $150 billion worth. With that, the government could keep pumping state money into the economy for months. Thus there’s a little slack time for the most recent round of reflationary measures to take effect.

“Basically this is the last chance to reflate,” Qu said. “If this policy is not going to work, then I don’t know what’s going to happen. All I can say is that the consequences are going to be very serious, but in what ways are totally unpredictable.”

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China Slows

Though China’s economic growth appears robust by First World standards, the nation’s economy must expand more rapidly to absorb tens of millions of workers being displaced from state-owned enterprises. The latest growth is propped up by heavy government spending. Recent rate of growth in gross domestic product:

1999*: 7%

*Government’s target for the year

Source: China State Statistical Bureau