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To: Bobby Yellin who wrote (37217)	7/16/1999 6:41:00 AM
From: Alex	Respond to of 117064

Is the Renminbi a Millstone Around China's Neck? The banking sector is weak and economic deflation rolls on. China's exchange rate peg was a rock of stability in the Asian crisis. Now there are hints that the country's leaders are starting to see it instead as a millstone around their necks. With the region on the road to recovery, it is time to look again at whether the currency is at the right level. On competitiveness grounds alone, the case for devaluation is not convincing. There has been a significant bounce back in other Asian currencies. True, China's trade surplus declined by 65 per cent in the first half of the year; but some of this is a result of a crackdown on smuggling. But a change in the exchange rate may be needed for another reason - to counteract the severe deflation crippling the economy. Prices in China have been falling for a year and a half. Personal saving is increasing at an annual rate of 20 per cent as consumers delay purchases and worry about job losses. Investment is in the doldrums, stockpiles are growing and companies are slashing prices to sell unwanted goods. The government's response so far has been a massively expansionary fiscal policy. This has succeeded in preventing a collapse in growth. But it has not stopped the deflationary spiral. Monetary policy is the obvious next step. Interest rates are close to six per cent, giving real rates of over nine per cent, much too high for an economy in need of stimulus. China's leaders have been reluctant to cut rates further because they fear a mass exit by depositors, which could trigger capital flight and a liquidity crisis in the banking system. These risks could be reduced by a more robust statement of support for the banks, and a strict application of capital controls. But still, the fragility of the banking system means that a drop in rates down to Japanese levels is impossible. Fiscal and monetary policy may not be quite enough. A case can therefore be made for a devaluation, which by raising import prices would help alleviate deflation. But China's exchange rate policy is not determined by economics. It has become a symbol of China's commitment to global stability, and a proxy for the fight between China's reformers, led by Zhu Rongji, who want to maintain the rate, and their opponents. A change in exchange rate policy would have to be conducted very carefully. It would have to be a gradual slide, rather than a one-off adjustment, and be of a modest size. Most importantly, to avoid panic, Mr Zhu must be seen to be totally in control. For the sake of regional stability, China's economy must be pulled out of its deflationary spiral. If this cannot be achieved through monetary and fiscal policy, then the risk of a devaluation may be worth taking. The Financial Times, July 16, 1999