Will China catch the Asian flu?

Abstract

The Asian financial crisis has engulfed most of the region's countries, with the notable exception of China, which has maintained a stable dollar exchange rate.However, China's situation is being widely discussed, some commentators claim that China will eventually be forced to devalue while others maintain that China neither needs to nor would gain from a devaluation. China, not yet a fully open economy, has the means and resources to withstand pressures against its currency.Reserves remain comfortable and the trade surplus is even growing as China's exports to the United States and Europe continue to grow at a healthy pace although exports to other Asian countries have slumped.Domestic economic activity is recovering from a slowdown as public expenditure is rising.However, rapid reform of China's state-owned industries and bad-debt ridden state-owned commercial banks may be endangered if foreign direct investment fails to pick up the slack in the labour market as stateowned industries and government ministries shed millions of workers.Chinese authorities might be tempted to ease the pressure through a devaluation of the renminbi.However, China's exports have an import content of 50 percent, so a small devaluation would make little difference, and a large devaluation would probably trigger a new round of competitive devaluations among the region's countries, in the end leaving everyone worse off than before.For the time being China is therefore best served by maintaining a stable exchange rate, but in the longer term China may have to reconsider the wisdom of its peg to the US dollar. Keywords: China, Asian crisis, devaluation, exports, trade surplus, exchange reserves, renminbi, reform