China’s financial muscle power
Mar 14 2013
Ever since, opening itself up to the world the People’s Republic of China has been very careful to maintain the sovereignty of its economic policies. This was the reason why the country has relentlessly increased its foreign currency reserves up to the point where it now has the by far biggest reserves in the world. With this mercantilistic policy, Beijing follows in the steps of Tokyo. It was indeed a cause for deep satisfaction, when few years back China replaced Japan as the country with the world’s biggest foreign currency reserves. With some $3.4 trillion worth of reserves, China has now around three times the reserves Japan can call its own.
The rapid growth of China’s foreign currency reserves is the result of a continuously high balance of payment surplus, a dynamic export industry and a restrictive currency policy. When in the late 1970s Deng Xiaoping started reforms, China was a desperately poor country. In many respects, China was poorer and less developed than India. The country had just come out of the self-inflicted damage caused by the so-called “cultural revolution”. Under these circumstances, reformer Deng Xiaoping had only two instruments at his disposal to restart the Chinese economy. On one hand, he liberated the farmers and removed the Soviet style collective farms, while on the other hand, Deng established special economic zones where foreign investors could produce for export.
Once the new economy took off, Beijing enlarged the reforms and laid out the red carpet for foreign investors. A large part of the foreign direct investments (FDI) that flood into the country comes from Chinese sources, be it from Hong Kong and Taiwan or from Chinese overseas communities in South East Asia and in the US and Canada. While the transparency of the financial sector in China is very limited and cannot be compared to India, the conditions for FDI in China are considerably better than in India. This is mainly due to the long-term planning and policies that are pursued by the leadership of the Communist Party and by the government. Foreign investors find that arbitrary changes in rules and regulations make it ever more difficult to go for long-term engagements in India.
When comparing socio-economic progress in India and China, we often come across the fact that Chinese are more systematic in their planning and procedures. Before going in for a massive industrialisation in the export sector, China built the necessary infrastructure, rails, roads and harbours to facilitate external trade. Even if India would have a manufacturing base of comparable strength to that of China, it would be of little use for the external trade balance without a massive infrastructure that facilitates trade. You only have to take a look at the harbours of Mumbai and Shanghai to see the gigantic backlog in modernisation that India still has to tackle.
The same goes for macro-economic growth strategies. Beijing’s reformers went step by step, the general goal being to make China strong and reduce external vulnerabilities. Underlying all this was the pronounced pragmatism of Deng Xiaoping, which not only made him choose solutions irrespective of whether they were capitalist or socialist, but which also led to the successful integration of the former British colony Hong Kong into China under his formula “one country, two systems”. There can be no doubt that the modernisation of the Chinese economy profits enormously from the window Hong Kong offers to the world and particularly from the assets and the experiences the former British colony has as a global financial centre.
In order to compete successfully on a global level, Chinas has built up financial muscle. Of course, the administration of the huge foreign exchange reserves is no easy matter. At present, Beijing is trying to reduce the huge exposure it has to the US dollar and to US treasury papers. This has to be done smoothly so as not to cause disruptions. Latest figures indicate that Chinas has reduced its holding of US treasury papers from $1.2 trillion to $1.15 trillion. China’s substantial US holdings are the major reason why Washington has muted its complaints about the artificially weak external value of the Yuan Renminbi. There is no doubt that with its rigid exchange rate mechanism, China is holding the Yuan artificially down in order to enhance the global competitiveness of its export industry. At some point, the US was even going to accuse China of currency manipulation. Now, with some countries aiming for competitive devaluation of their currency, the US needs the cooperation of China and has therefore, toned down its rhetoric — another indication how important it is for an upcoming world power to have substantial financial muscle power.
(The writer is the Far East correspondent of Swiss daily Neue Zurcher Zeitung)