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Monday, Sept. 18, 2006

JAPANESE PERSPECTIVES

China's tight yuan grip signals shortcomings as a global team player


Revaluation of the yuan, along with high oil prices, deceleration of the U.S. economy, and the euro's rise against the, yen was among the major topics discussed at the Group of Seven finance ministers' meeting in Singapore over the weekend.

The yuan issue has been getting more frequent attention because Chinese authorities have failed to liberalize trade in the currency fast enough — even though the quickly growing nation continues to sharply increase its foreign currency reserves.

Yuan trade is effectively limited to the Shanghai market, where participation is restricted, while operations controlled by Chinese financial authorities to prevent the yuan from appreciating have resulted in the rapid accumulation of forex reserves.

International frustration with China on this issue is growing because Beijing appears set to effectively postpone the pledge it made upon entering the World Trade Organization to fully open banking services to foreign firms by the end of 2006. Media reports say China is thinking of requiring foreign banks there to reorganize their branches into local enterprises if they want to handle yuan transactions on a retail basis.

On Nov. 27, 1996, the International Monetary Fund confirmed that China had accepted Article 8 of the IMF accord, in which a signatory promises not to restrict foreign-exchange transactions for reasons such as current account deficits. This officially gave China status as an "Article 8 member" on Dec. 1 that year.

At the time, the governor of the People's Bank of China also announced that the yuan would become a fully convertible currency in current account transactions as of that date. It was a promise not to impose restrictions on international current account payments or transfers, and not to adopt discriminatory currency measures or a dual currency exchange system.

Despite the transition to Article 8 membership and the rapid expansion in foreign trade China has seen in the years since, the yuan is not being traded in overseas markets.

This is because the Chinese government does not allow yuan trading except in Shanghai and Japanese banks do not quote the yuan exchange rates.

This is nothing less than a violation of the country's obligations under Article 8. The article does not set rules on possession of foreign currencies, but from the viewpoint of promoting international trade in goods and services it is considered an obligation of an Article 8 member to liberalize foreign-exchange holdings, investment and conversion into other currencies.

In years after World War II, what triggered the elimination of interest rate regulations in the United States and Japan was the role played by the Eurodollar and Euroyen markets. The ability to buy the dollar and yen in third countries led to the correction of interest and exchange rate distortions created by domestic regulations.

Today, a Euroyuan market does not exist because people are not allowed to hold yuan outside of China. In other words, the Chinese monetary authorities do not allow overseas possession of the yuan — despite its obligations under Article 8 of the IMF accord — in order to protect domestic regulations.

Despite Japan's current account surpluses, the yen is on a downtrend because of the exodus of yen-denominated funds from Japan, which has been suffering for years with rock-bottom interest rates. Since the short-term deposit rate is below the inflation rate, the interest rate on deposits is effectively in negative territory.

The yen-carry trade has resumed and is providing excessive liquidity worldwide. The yen's weakness has added to inflationary pressures caused by high oil prices, increasing the burden on consumers. Japan's monetary policies should take into account not just domestic concerns, but conditions overseas as well.

During the IMF's annual convention, to be held after the G7 meeting in Singapore, the U.S. reportedly plans to propose a review of the financial contributions and voting rights of China, South Korea, Mexico and Turkey. The measure is aimed at having these countries take greater responsibility for international financial affairs commensurate with their growing economic power.

However, some European nations, such as Britain and France, are believed to be cautious about giving these new economic powers a greater say, while India and Thailand are said to be opposed to letting the four move ahead of the pack.

Despite its status as one of the permanent members of the United Nations Security Council, China's financial contributions to the world body are extremely small.

Beijing is also under scrutiny for its aggressive worldwide hunt for natural resources, as well as support for countries accused of violating human rights.

China should fulfill its obligations to the international bodies to which it belongs, including the United Nations, IMF and WTO, and make financial contributions commensurate with its growing economic capacity.

Teruhiko Mano is a professor at Seigaku in University Graduate School.


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