[VIEWPOINT]Currencies, change and China

Although we can’t seem to revive our economy no matter what measures we try, China is worried because it is unable to slow down its overheated economy no matter what retrenchment policies it uses. China’s central bank recently raised borrowing costs for the first time in nearly a decade.
Earlier, a series of mostly administrative methods such as restraining loans and repeatedly raising banks’ required reserves had failed to curb the breakneck pace of the economy’s growth. The bank raised its benchmark rates on one-year yuan loans to 5.58 percent from 5.31 percent and the rate on one-year deposits to 2.25 percent from 1.98 percent. Our government and industrial sector are concerned about the effect China’s interest rate hike will have on our economy.
Moreover, should the yuan be revalued, a widespread concern, it would have dire effects on our exports, which are our economy’s last bulwark.
China’s interest rate hike was more or less predicted and the hike was not that big, leaving our exports reasonably intact for now. Raising the interest rates was part of the retrenchment measures, but it was also an effort to engineer a “soft landing” so as to avoid revaluing the yuan, which would have an even bigger effect on the Chinese economy.
But should the interest rate hike not have a big enough effect in slowing down the economy, there could be additional rate hikes and a revaluation of the yuan or even possibly an implementation of a free-floating currency exchange system. This would have huge consequences for our economy,
China’s interest rate hike will first cause a slowdown in the domestic economy, such as investment and consumption, and this will affect our exports. Our exports to China are mostly components and capital goods used for export industries rather than domestic consumption there. With the exception of fuel, car components, construction equipment and steel products, our exports will not be terribly affected for the time being.
But this interest rate hike will raise the financial costs of all businesses in China, including Korean companies, and constrain investment. That will, in turn, affect our exports negatively. Additional interest rate hikes or a revaluation of the yuan will shrink China’s import of goods for domestic consumption and weaken the price competitiveness of Chinese goods, decreasing China’s exports and affecting our component exports to China.
In the present situation, when our exports are the only thing holding up our economy, a decease in trade with China could deal a heavy blow to Korea. Of course, China’s interest rate hike and a revaluation would not have only negative consequences. The prices of raw materials would fall with constraints on overinvestment; concerns about China’s ability to engineer a “soft landing” would be somewhat lessened and our exports would have a better chance in price competition with Chinese goods.
Our exports to China are more complementary than competitive, however, and if the yuan were revalued, pressure to revalue the won would also increase. In the medium- to long-term, this forecasts gloom for our economy.
There are several measures our businesses could take to prepare for China’s retrenchment policies and the revaluation of the yuan. Companies that rely heavily on the Chinese domestic market should work to diversify their exports to newer markets such as India and Brazil. Our businesses should also aim to reform our product and industrial structures to aim for high-price markets with bigger growth potential. We should also continue to develop our technology to acquire a comparative superiority in the existing capital goods market. We should also set up a risk management system that would prepare us in case of contingencies such as a “China shock.”
Our government should work to eliminate uncertainties concerning government administration and policies and provide the necessary social conditions for firms to invest and enhance their competitive edge. It should refrain from its usually overt interference in the foreign currency market and establish more efficient currency exchange policies in closer cooperation with other East Asian countries to prepare for the possible revaluation of Asian currencies including the yuan. The government’s priority in managing the economy should be to enhance our country’s competitive edge.

* The writer is a professor of economics at Hanyang University and the president of the Korean Association of Public Finance and Economics. Translation by the JoongAng Daily staff.

by Na Seong-Lin