Saving the Global Trading System


May 22, 2017

Saving the Global Trading System

By Editors,  Eastasiaforum.com

International trade and investment lift living standards. The evidence for this is irrefutable. And modern economic development is not possible without opening up to international markets, competition and capital.

Image result for The Global Trading system

But the world is re-learning the hard way, through Brexit and the rise of Donald Trump, that institutions and policies that protect the immediate losers from trade are needed to realise and sustain the benefits of open markets. Having a healthy and a well-functioning macroeconomic environment — one that delivers what economists call full employment — and a flexible labour market are crucial. So is having an effective social protection system.

When economic growth slows it is harder for the winners from globalisation to compensate the losers. The United States’ slow recovery from the global financial crisis, which hit close to 10 years ago, has brought these underlying structural problems into sharp focus. The social safety net is in tatters with the healthcare system, education system and redistributive policies exacerbating inequality — inequality in both opportunity and outcome — and bringing into question the American dream.

Australia, Japan, and many other countries have been able to avoid the retreat from globalisation thanks to well-functioning social protection systems. There may have been an inclination in many countries to adopt US institutions since it is the richest, most advanced and powerful economy in the world, but the lesson from Trump’s rise is a clear warning that now is the time to double down on the social safety net when embracing free and open markets.

When times are tough in any country there is immense pressure to put up barriers to foreign competition as a way to protect domestic producers. Protection may bring short-term relief to some parts of society and have short-term political appeal but is a cost to society as a whole, as well as to other countries.

Image result for The Global Trading system

The global trading system has been stopping countries from committing self-harm for 70 years. The General Agreement on Tariffs and Trade (GATT) which later became the World Trade Organisation (WTO) was created in response to countries’ retreating to protectionism after the Great Depression. Countries voluntarily signed up to be bound by the rules and norms of that system and to have disputes with other countries settled within that system.

The 153-member WTO is far from perfect but it has underpinned successful globalisation. The large membership and diverse interests of the WTO have frustrated the completion of the Doha Round of trade negotiations. The WTO does not cover foreign direct investment and many other issues relevant to commerce in the 21st century. But its dispute settlement mechanism continues to function well and has resolved trade frictions that in an earlier time may have escalated into trade if not military conflict. High profile, geo-politically charged disputes such as the alleged Chinese rare-earth metal export embargo against Japan have been resolved peacefully in the WTO with China accepting the ruling against it.

Image result for Roberto Azevêdo,

Three Amigos from of WTO, World Bank and IMF

In this week’s lead essay, Director General of the WTO, Roberto Azevêdo, reminds us that a ‘strong, rules-based trading system is essential for global economic stability’ and explains how that system can be re-energised.

Multilateral trade deals required all members to sign on to the entire agreement, called a single-undertaking, that made it harder to complete the latest round of negotiations, the Doha Round, as the issues became more complex and the number of countries increased. Azevêdo explains the WTO is ‘learning to be ambitious, but also to be pragmatic, realistic and flexible’, as well as ‘creative, finding innovative solutions and engaging in flexible formats’.

That is all good news for making progress on freeing up trade and reviving slumping global trade growth. But the bigger risk is that the WTO itself could be under threat from the United States, the very country that led its creation and which has underwritten the rules-based order for the past 70 years. The United States and Europe have provided a tailwind for the global economic system but have now turned to become the headwind against its forward movement.

President Trump has not carried through on many of his campaign promises and the world holds its breath in the hope that continues. While he withdrew the United States from the 12 member regional trade agreement the Trans-Pacific Partnership, he has not acted on tearing up existing trade agreements, starting a trade war with China or Mexico, or withdrawing from the WTO. But if jobs do not return in the American rust belt — perhaps as US interest rates rise and the dollar strengthens, or just because many of those jobs are gone for good — and Trump needs to demonstrate action on trade, the world will need to be ready to hold the line against following suit and to save the entire system.

Azevêdo explains that East Asia and the Pacific have a key role to play in boosting trade for jobs, growth and development. Asia will play the key role in saving the global trading system and global economy, if it is to be saved.

China is the world’s largest trader, a remarkable story only made possible with its accession to the WTO in 2001. The world, including the United States, has benefited greatly from China’s success. China’s economy is now the second largest in the world and still depends on open markets for development and its pursuit of prosperity. But China alone cannot lead the global fight against protectionism if the United States turns its back on globalisation.

South Asia and many countries in Southeast Asia need open markets to bring millions out of poverty and into the workforce. Japan and South Korea need open international markets to execute difficult reforms to manage shrinking populations. Asia is now a major growth engine in the global economy and has the interest, ability and responsibility to save the global rules-based order.

The EAF Editorial Group is comprised of Peter Drysdale, Shiro Armstrong, Ben Ascione, Amy King, Liam Gammon and Jillian Mowbray-Tsutsumi and is located in the Crawford School of Public Policy in the ANU College of Asia and the Pacific.

Stop the Spin: 1MDB actually capitulated to Abu Dhabi


May 4, 2017

Stop the Spin: 1MDB actually capitulated to all IPIC (Abu Dhabi) demands

by P. Gunasegaram@www.malaysiakini.com

Image result for 1MDB and Abu Dhabi

A Replay of Ali Baba al Najib and his 1MDB forty thieves–Malaysia Boleh

Desperation causes stupidity to rise to the fore.Take 1MDB and the way it spins its so-called settlement with Abu Dhabi’s International Petroleum Investment Company (IPIC), the parent company of Aabar Investments PJS. There was a dispute and it was settled, but there was no renegotiation. 1MDB capitulated to all IPIC demands.

But this has been spun to give the false impression that all matters have been settled between the two. Ministers rushed to make statements about how the eventual settlement will be in favour of 1MDB and how it indicates that no money went into Najib Abdul Razak’s accounts.

Singapore’s The Straits Times, which broke the news on the settlement, even preposterously reported that the settlement will make it more difficult for the US Department of Justice or DOJ to continue with its actions relating to 1MDB. It is difficult to see how because it caused no change in money flows.

The Straits Times reported that the “successful implementation of the proposed settlement could impact legal action being considered against 1MDB by foreign governments, including the DOJ.

“Bankers and legal executives (unnamed) familiar with the situation believe the deal could significantly dilute the international legal challenges confronting Prime Minister Najib Abdul Razak’s administration over the fallout from the 1MDB saga.”

The report continues: “…Here is why. The disputed monies in the Malaysia-Abu Dhabi row are central to legal suits brought by the US Department of Justice over the alleged misappropriation of funds from 1MDB. The Department of Justice claims that the funds siphoned from 1MDB went to fund purchases of real estate and other assets by associates of PM Najib.

Image result for 1MDB and Goldman Sachs

“The settlement agreement between Malaysia and Abu Dhabi would achieve what is known in legal parlance as ‘no predicate offence’, the financial executives said.

“A predicate offence is a crime that is a component of a more serious crime and it is frequently applied in the US to actions involving the provision of funds for money-laundering and the financing of terrorism.

“Proponents of the settlement between Malaysia and Abu Dhabi argue that a successful completion of the deal would weaken the impact of any legal action taken by foreign governments over alleged money-laundering at 1MDB because of the lack of evidence,” The Straits Times said.

However, as it stands, US$3.5 billion is still missing and in dispute and IPIC says it never received the money. In this case, clearly the main offence is allegedly stealing money from 1MDB and the predicate offence is the laundering of part of this money in the US.

Everything that the DOJ has reported remains unaltered despite the settlement. Its case remains as strong as ever. The DOJ report says that US$3.657 billion was stolen from 1MDB (the main offence) and part of it was laundered in the US (the predicate offence).

Paying twice for same bonds

Under the settlement, despite outstanding issues, 1MDB agreed to pay RM1.2 billion to IPIC and the US$3.5 billion in two bonds are now guaranteed by 1MDB and Malaysia’s Minister of Finance Inc, instead of jointly with IPIC/Aabar before.

That’s a cost of at least US$1.75 billion (half of the value of the bonds) to 1MDB and leaves 1MDB with no more bargaining power at all. And the US$3.5 billion that 1MDB paid to the wrong Aabar – the one suspiciously incorporated in the British Virgin Islands – is still a matter of dispute.

This will be part of ongoing negotiations. “The parties have also agreed to enter into good faith discussions in relation to payments made by 1MDB Group to certain entities,” IPIC’s filing to the London Stock Exchange states.

Clearly this has not been settled, and as MP Tony Pua, one of the most knowledgeable people about 1MDB, had correctly pointed out, by taking over the guarantee that was previously jointly provided with IPIC, 1MDB is effectively paying twice for the same bonds – some US$7 billion in all! That US$3.5 billion, or over RM15 billion, at current exchange rates still remain missing.

Image result for Malaysia's Second Finance Minister JohariNajib got this former Second Minister by the Bees–Gone Missing

This is where Finance Minister II Johari Abdul Ghani comes in to disclose the existence of a letter confirming that Aabar Investments PJS Ltd (BVI) – the one incorporated in British Virgin Islands, is a subsidiary of IPIC even though the Abu Dhabi firm denies this.

“As far as I am concerned, based on records provided by 1MDB to the Public Accounts Committee (PAC) prior to the settlement agreement, Aabar Investments PJS Ltd (BVI) is a subsidiary of IPIC. A fact which was confirmed by the Registrar of Corporate Affairs of the British Virgin Islands by its letter dated Aug 11, 2016,” Johari told Malaysiakini.

But as far as IPIC is concerned, it’s not and that’s what matters. If 1MDB and Malaysia thought otherwise, why would they let IPIC off the hook by assuming the guarantee in full? And there’s no chance IPIC is going to say different in future. The question to ask is, why did 1MDB make a payment to a so-called subsidiary instead of directly to Aabar or IPIC? Was it to deliberately siphon funds out of 1MDB?

And then Minister in the Prime Minister’s Department Abdul Rahman Dahlan said that the settlement shows no money went into the Prime Minister’s account. He is saying that the money is in the form of unit trusts, presumably because 1MDB, in its own scant statement, said that the US$1.2 billion will be monetised from the unit trusts.

But really, that’s not true at all. The DOJ report clearly shows that during different phases of money moving out of 1MDB and into various accounts, a total of US$731 million came into Najib’s accounts between 2009 and 2013. Subsequently, US$620 million moved back into accounts controlled by Jho Low, leaving a net of US$111 million in Najib’s accounts still (see chart).

In the face of desperation, reason has been flung out the window and the increasing ridiculousness of 1MDB’s assertions, those of some ministers and even foreign news reports which appear to have been taken up by 1MDB’s propaganda machine, is a sign – if that was needed – that 1MDB is still very much in dire straits. And that much is being done deliberately to hide the extent of the problems. Still, it will continue to haunt Najib and his administration for a long time more.


P GUNASEGARAM says that truth eventually resurfaces despite all attempts to hold it underwater. Email: t.p.guna@gmail.com.

 

IMF on Malaysia–Report Card


May 3, 2017

International Monetary Fund on Malaysia–Report Card

by The International Monetary Fund

Image result for putrajaya malaysia

Putrajaya–The Administrative Capital of Malaysia

The IMF conducts an Annual Review of member country economic situation. At the conclusion of the consultations the Executive Board considers the findings which are also conveyed to the Government. A Press Release is issued  together with access to the full staff report on the Fund’s website. The Report  is in the nature of a “Report Card”.

The text of the Press Release is reproduced below. The full report can be accessed and downloaded from  ::

http://www.imf.org/en/Publications/CR/Issues/2017/04/28/Malaysia-2017-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-the-44869

On March 15, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Malaysia.

Despite a challenging global economic environment, the Malaysian economy performed well over the past few years. Notwithstanding the impact of the global commodity price and financial markets volatility, the economy remained resilient, owing to a diversified production and export base; strong balance sheet positions; a flexible exchange rate; responsive macroeconomic policies; and deep financial markets. While real GDP growth slowed down, Malaysia is still among the fastest growing economies among peers. The challenging global macroeconomic and financial environment puts premium on continued diligence and requires careful calibration of policies going forward.

Risks to the outlook are tilted to the downside, originating from both external and domestic sources. External risks include structurally weak growth in advanced and emerging market economies and retreat from cross-border integration. Although the Malaysian economy has adjusted well to lower global oil prices, sustained low commodity prices would add to the challenge of achieving medium-term fiscal targets. Heightened global financial stress and associated capital flows could affect the economy.

Domestic risks are primarily related to public sector and household debt, along with pockets of vulnerabilities in the corporate sector. Federal debt and contingent liabilities are relatively high, limiting policy space to respond to shocks. Although the household debt-to-GDP ratio is likely to decline, household debt also remains high, with debt servicing capacity growing only moderately.

Real GDP growth rate is expected to increase moderately to 4.5 percent year-on-year (y/y) in 2017 from 4.2 percent in 2016. Domestic demand, led by private consumption, continue to be the main driver of growth, while a drag from net exports, similar to 2016, will remain.

Consumer price inflation is projected to rise and average 2.7 percent y/y in 2017 on the back of higher global oil prices and the rationalization of subsidies on cooking oil. The current account surplus would be largely unchanged as impacts from an improved global outlook and higher commodity prices would be offset by the strength of imports on the back of a resilient domestic demand.

Image result for Bank Negara Malaysia

Bank Negara Malaysia—in full control of the Pulse of the Malaysian Economy

Executive Directors commended the resilience of the Malaysian economy, which reflects sound macroeconomic policy responses in the face of significant headwinds and risks. While Malaysia’s economic growth is expected to continue in 2017, weaker-than-expected growth in key advanced and emerging economies or a global retreat from cross-border integration could weigh on the domestic economy. Against this background, Directors urged vigilance and continued efforts to strengthen policy buffers and boost long-term economic growth.

Directors agreed that the authorities’ medium-term fiscal policy is well anchored on achieving a near-balanced federal budget by 2020. The planned consolidation will help alleviate risks from elevated government debt levels and contingent liabilities and build fiscal space for future expansionary policy, as needed.

Directors recommended that the pace of consolidation reflect economic conditions and that any counter-cyclical fiscal policy measures be well-targeted and temporary. They noted that improvements to the fiscal framework, such as elaborating medium term projections and preparing and publishing an annual fiscal risks statement, would help anchor medium-term fiscal adjustment and mitigate risks.

Directors agreed that the current monetary policy stance is appropriate. Going forward, Bank Negara Malaysia (BNM) should continue to carefully calibrate monetary policy to support growth while being mindful of financial conditions.

Directors emphasized that global financial market conditions could affect the monetary policy space and should be carefully monitored.

Directors noted that the banking sector is sound overall and that financial sector risks appear contained. Nonetheless, they cautioned that potential pockets of vulnerability should be closely monitored. They noted that household debt remains relatively high, while in the corporate sector, there are emerging vulnerabilities in some sectors. Directors suggested that macroprudential measures be adjusted if needed.

Directors underscored the central role of macroeconomic policy and exchange rate flexibility in helping the economy adjust to external shocks. In this regard, they welcomed the authorities’ commitment to keeping the exchange rate as the key shock absorber. They recommended that reserves be accumulated as opportunities arise and deployed in the event of disorderly market conditions. Noting the authorities’ aim to improve the functioning of the onshore forward foreign exchange market, Directors urged the BNM to monitor the effects of the recent measures introduced in this regard, recognizing their benefits and costs.

They emphasized that close consultation and communication by BNM (Bank Negara Malaysia–Central Bank) with market participants will be essential in further developing the foreign exchange market and bolstering resilience.

Directors underscored that steadfast implementation of the authorities’ ambitious structural reform agenda is key to boosting long-term economic potential. They supported the emphasis on increasing female labor force participation, improving the quality of education, lowering skills mismatch, boosting productivity growth, encouraging research and innovation, and upholding high standards of governance.

At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

International Finance Ministers Discuss Growth Strategies at The George Washington University


April 26, 2017

International Finance Ministers Discuss Growth Strategies

GW-hosted event, “Growth Strategies in a De-Globalizing World,” brought finance ministers from Colombia, Indonesia and Paraguay.

Finance ministers Mauricio Cárdenas, Sri Mulyani Indrawati and Santiago Peña

Finance Ministers Mauricio Cárdenas, Sri Mulyani Indrawati and Santiago Peña discussed their countries’ growth strategies, including focusing domestically in an uncertain global market. (Logan Werlinger/GW Today)
April 20, 2017

 

https://gwtoday.gwu.edu/international-finance-ministers-discuss-growth-strategies

As the International Monetary Fund and World Bank Group spring meetings loomed, the George Washington University on Wednesday hosted international finance ministers and other experts to discuss the global economic landscape and implications for countries trying to grow in a “de-globalizing” world.

The event—hosted by GW’s Institute for International Economic Policy, GW School of Business and the Growth Dialogue—brought together the current finance ministers from Colombia, Indonesia and Paraguay and was moderated by Danny Leipziger, GW professor of practice of international business and managing director of the Growth Dialogue.

“The world is not in a good place,” Dr. Leipziger said in framing the discussion, adding many “warning signs” show countries’ difficulties with growing their economies, particularly at a time when others, including the U.S., are questioning globalization.

Does that mean that countries’ development strategies need to shift? And if so, how? Many agreed that looking inward is important during times of global uncertainty.

“We have to rely on domestic forces,” said Mauricio Cárdenas, Colombia’s minister of finance and public credit, adding infrastructure and brokering national peace and stability are important factors in growing his country’s economy.

Image result for sri mulyani indrawati muda
Sri Mulyani Indrawati of Indonesia

Sri Mulyani Indrawati, Indonesia’s Minister of Finance, added that while increasing revenues is important for a country, so is a good spending plan when every dollar counts. “How you spend it, and how you spend it better, is going to also be very critical,” she said.

Looking at trade inter-regionally could also be an important tactic if engaging with the broader globe is difficult, said Santiago Peña, Paraguay’s minister of finance. Many countries in Asia have been able to do this and have coped better with global changes, he said.

Panelists also said growth worries are compounded by uncertainty surrounding some of the rhetoric and policy actions of the Trump administration with respect to globalization and declarations that certain countries have a trade surplus with the United States.

“I hope that GW is also playing an important role in this location because you have a moral responsibility to continue pushing back the policy trend which is worrying for many countries in the world,” Ms. Indrawati said.

Adam Posen, president of the Peterson Institute for International Economics, had some advice for the finance ministers with respect to engaging with the United States.

“One just has to assume for the next couple of years at a minimum that the U.S. is going to be, at best, a bad actor,” when it comes to trade and other international partnerships, he said.

Image result for the george washington university campus

1MDB Energy Assets to China–What’s the Quid Pro Co?


April 21, 2017

1MDB Energy Assets to China–What’s the Quid Pro Co?

by P.Gunasegaran@www.malaysiakini.com

Image result for najib razak the liar

Thank You, King, for the Donation. but not enough that is why I have to sell 1MDB Energy Assets to China. The financial hole is too big. Sorry bro, no more from me since my Kingdom needs money for our own needs.

The signing of the power purchase agreement (PPA) last week between national power utility Tenaga Nasional Bhd and Edra Energy Sdn Bhd, formerly owned by Malaysia’s infamous 1MDB and now owned by China company CGN Group, puts Edra under public scrutiny yet again.

This is a good time to note the enormous, potentially adverse implications that Edra has on our energy industry.

First, ever since independent power producers (IPPs) were introduced in the 90s, this is the first time that Tenaga is signing a deal with a 100 percent foreign-owned entity – all previous PPAs were signed with locally owned companies which have at least 30 percent bumiputera participation.

Second, the deal clearly shows that future development of IPPs were included in the sale price of RM9.83 billion paid by CGN to 1MDB, as pointed out by an article in The Sun newspaper.

This has major implications and may indicate that not sufficient account was taken of this in the sale price.

Image result for najib razak the liar

According to the article, at the time of the announcement of the sale in 2015, 1MDB held two project awards that were yet to the developed, a 2,000MW combined cycle gas turbine venture and a 10x50MW utility scale solar power plant, which are also in the list of assets sold. At the time, no confirmation was made on whether the rights had been transferred to CGN.

1MDB agreed to sell Edra Global Energy to CGN Group for RM9.83 billion cash in November 2015 with the sale completed March 2016.

1MDB had paid a total of just over RM12 billion for the power assets earlier, all owned by Malaysian entities – RM8.5 billion from Ananda Krishnan’s Tanjong Energy Ventures renamed Powertek Energy Group, RM2.3 billion from the Genting group and RM1.23 billion for Jimah Energy Ventures.

Even so, analysts felt that CGN overpaid for the assets by about RM1 billion. However, with future power development ventures included, it looks like overpayment, if any, may have been a lot smaller.

But consider the implications of this – prime power assets, not just in Malaysia but in other countries as well, were sold off to a foreign company from China, basically switching ownership of these assets out of the country. 1MDB is fond of saying that it is a strategic development company owned by the government – how strategic is that?

Despite the overpayment, 1MDB’s only earning assets within its rather dubious acquisitions were the power assets under Edra.

It is telling that despite loans at one stage of RM42 billion in its books and few assets to show, it had to sell Edra to quash bank debts which were becoming fast due – clear evidence of major problems at 1MDB.

Some of the bond issues were taken to buy the energy assets but were diverted elsewhere.

Image result for najib razak the liar

Najib Razak and his Kaki Bodeks

There is legitimate concern that this rescue of 1MDB by CGN is a quid pro quo for other China deals such as the RM55 billion East Coast Rail Line project and the RM40-80 billion KL-Singapore high-speed rail.

Under the latest PPA, Edra will construct, own, operate and maintain a gas-fired combined cycle electricity generating facility with a total nominal capacity of 2,242 megawatts to be located at Alor Gajah, Malacca.

It will consist of three generating blocks, and an expected commercial operation date of Jan 1, 2021 for the first generating block, March 1, 2021 for the second generating block and May 1, 2021 for the third generating block.

The PPA governs the obligations of the parties to sell and purchase the generating capacity and, to the extent dispatched, the electrical energy generated by the facility. The PPA will be for a period of 21 years from the commercial operation date of the first generating block.

However, the purchase price for electricity is not disclosed by Tenaga and it was not possible to obtain any figures from the Energy Commission website as well.

Scarcity of info on IPPs

From the time former Prime Minister Dr Mahathir Mohamad introduced IPPs in the 90s, there has been a scarcity of good information on IPPs and their deals – however one thing is clear, billions have been made by people who were essentially cronies of the PM and the ruling party then.

Over the years, the deals for IPPs have gotten progressively more in favour of Tenaga but Edra may jettison the progress made – there needs to be transparency to ensure that deals that are too favourable to IPPs are not signed as it was in the past.

For that, two quantities need to be disclosed – the purchase price for the electricity and the internal rate of return (IRR – the financially correct way of measuring returns) for the project.

The second needs to be audited by qualified people and their significance properly explained.Otherwise we are going to see a second round of masking of benefits, this time to foreigners.

Remember that Edra is no longer Malaysian but foreign owned – all 100 percent of it. And therefore it should no longer be entitled to the benefits that Malaysian companies get.

‘Malaysia first’ should be our slogan too. A Bernama article in April last year quotes Edra President and Executive Director Mark Ling who said the recent RM9.83 billion acquisition of Edra by CGN puts Malaysia in a strong position to develop ASEAN’s power sector. He of course got it wrong – it does not put Malaysia in that strong position but China.

He further said that Edra, backed by CGN’s capitalisation of US$60 billion, was now able to link through the Trans-ASEAN grids from the Philippines to Sabah, down to Sarawak and Sumatra.

“We are now able to immediately further enhance opportunities and commitments, opportunities which have been knocking at our door previously but which we were unable to entertain,” he said.

“And to actually have a Sarawakian lead Edra, it’s a great honour for us Sarawakians. We have to understand that we have got no barriers in convincing the rest of the world that we can do it. And I will be looking seriously into avenues of new energy businesses in Sarawak.”

Rather propaganda-ish! Well, if that’s the case, this means that this China-owned company is all set to get even more projects and that is extremely worrisome when you consider that Malaysian companies have the ability and the know-how to do the same – we never needed any help from China before.

Think Tenaga for instance. Why are we passing the baton on to a China company after spending so much effort to nurture and develop an indigenous power generation industry with international capability?

Is this yet another mysterious strategic development initiative followed upon by an earlier one by 1MDB? How much will we end up eventually paying for 1MDB’s transgressions in addition to the tens of billions of ringgit already lost and stolen?

P GUNASEGARAM says desperation and corruption are a potent combination for bad business. E-mail: t.p.guna@gmail.com.

The Renminbi and the Rise of China in Global Trade and Finance


April 10, 2017

The Renminbi and the Rise of China in Global Trade and Finance

by Paola Subacchi, Chatham House

http://www.eastasiaforum.org

“…any suggestion that the renminbi may one day rival the dollar and seriously threaten the greenback’s dominance within the international monetary system remains wishful thinking. The renminbi is moving in the right direction, but much more needs to be done to make it into a pillar of this multi-currency system.”–Paola Subacchi

At times of big turmoil, currencies take the hit, but economic transformation can also create currency winners. Nowhere is this more apparent than when we compare the prospects of British sterling and China’s renminbi.

Image result for the renminbi as an international currency

Between February 2016 — when the referendum on the UK’s membership of the European Union (EU) was announced — and the end of January 2017, the sterling fell by 14 per cent against the US dollar. Then, at the beginning of October, when the UK government appeared to signal a preference for a clear break with the EU — a ‘hard Brexit’ — the sterling dropped again by 6 per cent.

As the British government is serving notice on the membership of the EU, it is not yet clear what the future relationship will look like. Will Britain remain a member of Europe’s single market? Or will it embrace a totally independent trade policy to maintain control at its borders?

Currencies not only reflect geopolitical dynamics, but also patterns of trade and debt. A weak currency is not much help for an economy that imports more than it exports. The UK has a significant deficit in its current account — roughly, it consumes more than it produces — at almost 6 per cent of GDP. Of course, a weak currency would lower the prices of exports, but only if these goods are produced with limited inputs from imports.

In a world of global supply chains this is questionable. Even assuming that a weak sterling would help shift the UK model of growth from domestic demand to exports, this adjustment will take time and is unlikely to cushion the adverse impact of Brexit on real GDP growth in the next few years.

The ‘hard Brexit’ option, by reducing market openness, will affect investors’ confidence, have an adverse impact on capital inflows and undermine growth. If the UK becomes less attractive as an investment destination, and stricter immigration policies cause the labour force to shrink, then Britain may find it difficult to attract the quantity of foreign capital and labour necessary to sustain a domestic demand-driven economy.

Image result for the sterling post Brexit

The sterling remains in the IMF’s Special Drawing Rights (SDR) basket of international reserve currencies. To some extent the sterling has been a proxy of British global influence: on the way down, but still ‘punching above its weight’. But the sterling’s protracted weakness coupled with the inclusion of the Chinese renminbi in the SDR basket — in effect from the beginning of October 2017 — may result in downgrading the pound when the composition of the basket is reassessed in 2020.

If currencies are an expression of national sovereignty, they also epitomise the limits of such sovereignty in an open economy. Exchange rate dynamics tend to reflect divergences between domestic politics and global markets. Thinking that domestic policy making can be insulated from the rest of the world, so that no coordination or cooperation is needed, is deeply fallacious. The sterling’s troubles are a reminder that foreign investors have an indirect say — and interest — in how a country is managed.

The inclusion of the renminbi among the currencies that compose the SDRs — the US dollar, the euro, the yen and the sterling — is a ‘milestone’ for China, as International Monetary Fund Managing Director Christine Lagarde said when she presented the IMF executive board’s decision on 30 November 2016.

The renminbi’s inclusion recognises the work that China’s monetary authorities have done in the last five years to push the renminbi’s transformation into an international currency — a currency that can be used to invoice and settle international trade and that is traded in international capital markets. The outcome of this process has been remarkable: approximately 25 per cent of China’s trade is now settled in renminbi — it was less than 1 per cent in 2009.

In addition, the inclusion somehow addresses the contradiction that China has faced for years: being the world’s second largest economy and the largest exporter without a currency that reflects that role. For years the dollar has been the currency used in China’s trade and investments, and this is still largely the case. This has suited China well throughout its transformation from a poor and isolated nation into an industrial powerhouse that is well integrated in regional and international supply chains.

But China’s dollar dependence no longer reflects Beijing’s ambitions for playing a more engaging and assertive role in international economic and financial affairs and governance. If ‘great nations have great currencies’, to paraphrase Nobel laureate Robert Mundell, then it is understandable that the Chinese leadership would push to turn the renminbi into a ‘great currency’.

Finally, and even more critically, being part of the SDR basket implicitly recognises the role that the renminbi, going forward, can play in the international monetary system. The hype that has surrounded the IMF decision — the SDR made headlines beyond the financial press, perhaps for the first time since its creation in 1969 — should not obscure the fact that the development of the renminbi is not a linear process, even if it is heavily policy-driven, and there is no guarantee that progress will continue at the same remarkable pace. The renminbi remains a currency with limited international circulation because of obstacles that are still in place to constrain capital flows into and from China’s domestic market.

Image result for the renminbi as an international currency

This is not the case for trade transactions, where the renminbi has been fully convertible since 2001 when China joined the World Trade Organisation. But what is the incentive for foreign businesses to hold renminbi if liquidity is constrained and therefore so are investment opportunities?

To make the renminbi into an international currency that foreigners want to hold as a store of value the Chinese leadership needs to continue the pace of reforms. Top of the list is the exchange rate and the abandonment of the system where the central bank intervenes every time the value of the renminbi moves outside a pre-determined range. Until foreign investors believe that the renminbi is liquid and trustworthy, any suggestion that the renminbi may one day rival the dollar and seriously threaten the greenback’s dominance within the international monetary system remains wishful thinking. The renminbi is moving in the right direction, but much more needs to be done to make it into a pillar of this multi-currency system.

Paola Subacchi is Director of Economic Research at Chatham House, London, and the author of The People’s Money: How China Is Building a Global Currency (Columbia University Press, 2017).