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Pegged regime called ''highly distortionary'' and ''a risk to China's economy, its trading partners and global economic growth''

WASHINGTON, DC - 05/18/05 - China must move to a more flexible exchange rate if it is to avoid future designation as a currency manipulator, says the US Treasury Department in its semiannual report to Congress on foreign exchange-rate policies.

China's currency policies "are highly distortionary and pose a risk to China's economy, its trading partners and global economic growth," according to the report.

Concerns of competitiveness with China, it said, "also constrain neighboring economies in their adoption of more flexible exchange policies. If current trends continue without substantial alteration, China's policies will likely meet the statute's technical requirements for designation." 

According to the report, "While China's ten-year-long pegged currency regime may have at times contributed to stability, it no longer does so."

The peg, it said, "blocks the transmission of critical price signals, impedes needed adjustment of international imbalances, attracts speculative capital flows and is a large and increasing risk" to the Chinese economy.

"Indeed, Chinese officials have publicly acknowledged the need to move to a more flexible system, have repeatedly vowed to do so and have undertaken the necessary and appropriate preparations," the report said.

"It is widely accepted that China is now ready and should move without delay in a manner and magnitude that is sufficiently reflective of underlying market conditions," it said.

US trade law - nemely, the Omnibus Trade and Competitiveness Act of 1988 - has required annual compilation of the report since 1988.

Under that legislation, if Treasury finds that a country has "significantly harmed" US trade through foreign exchange rate manipulations, the secretary [of the Treasury] is required to begin "expedited" negotiations to change the practice.

The report said that no major US trading partner manipulated its exchange rates in the last six months of 2004. 

After reviewing developments in the US, the report evaluates exchange rate policies in major economies across five regions of the world - the Western Hemisphere; Europe and Eurasia; Sub-Saharan Africa; the Middle East and North Africa; and South and East Asia.

Nonetheless, Treasury Secretary John Snow's statement on the report dealt extensively with China, which has maintained a fixed exchange rate of 8.28 yuan to the US dollar for the last ten years. 

"Our engagement with China over the past two years … leaves me with little doubt that China is now prepared to begin reform of the currency regime," said Snow.

Chinese officials have said they want to adopt a more flexible currency, but that they need time to prepare their financial system for the adjustment.

According to some US manufacturers, the peg grossly undervalues the yuan, making Chinese goods cheaper in the United States and US goods more expensive in China, thus contributing to the large US trade deficit with that country.

Some members of Congress, in reaction to what they have said is China's "undue delay" in moving to a more flexible rate, have introduced bills to impose sanctions on Chinese imports.

Snow, saying that debate on China's currency regime has been "clouded" by misconceptions of US policy, said that the US is not calling for an immediate switch to fully flexible rates.

"This would be a mistake at this time - China's banking sector is not prepared. What we are calling for is an intermediate step that reflects underlying market conditions and allows for a smooth transition - when appropriate - to a full float," he added.

US policy-makers understand that a more flexible currency system in China will not, taken alone, solve global imbalances, Snow said. 

"However, greater flexibility in China and other Asian economies is a necessary component," he said.

Snow also disputed claims that a more flexible system will increase Chinese unemployment.

"In fact," he said, "A flexible system will provide China with a more sophisticated array of policy tools - namely an independent monetary policy - that will prove much move effective in achieving price stability and the ability to adjust to shocks."

The Treasury report concluded that that the department "will continue to engage with China and closely monitor changes in its foreign exchange policy over the coming weeks and months."

The agency will also keep an eye on "China's "progress on foreign exchange market developments over the next six months" in advance of the next monetary report, which is scheduled for release in October, it said.

The full semiannual Treasury Department report can be accessed at www.treas.gov/press/releases/reports/js2448_report.pdf

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