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Exchange rate mechanism - A new talking point at the WTO

ECONOMISTS in the US in the past year or two have been stressing the imperative need for a significant depreciation of the US dollar against the other major currencies of the world. This, it has been repeatedly pointed out, is the only way of correcting the US' "unsustainable" trade deficit.

A significant portion of this opinion is (still) directed primarily at China, with suggestions for the further revaluation of the yuan. Fred Bergsten, Morris Goldstein, Nicholas Lardy, and Michael Mussa from the Institute for International Economics (IIE) in Washington DC, all suggest that an immediate 20-25 per cent appreciation of the yuan is warranted. The intrinsic logic for the revaluation is explained in a simple example. Conventional wisdom has it that if the dollar is valued at Rs 40, exports from India can become more competitive if the dollar is priced at Rs 50. This would mean more rupees for the exporter and he can price his exports lower.

In contrast, any imports which could have been "competitive" when the dollar was valued at Rs 40, may become "uncompetitive" at Rs 50. By ensuring the value of the dollar at Rs 50, India would get the benefit of increased protection or an additional advantage of 25 per cent over the baseline rate of Rs 40. The exchange rate mechanism thus offers tremendous leeway to countries to offer protection to domestic industries. This has been a point of contentious debate within the WTO.

Over the past couple of years the US has been putting great pressure on China to revalue by 30 per cent its currency, the yuan, which has been fixed at an exchange rate of 8.28 to the dollar since 1995. The US felt that this fixed exchange rate regime, as practised by China, was unacceptable as it implicitly subsidises exports from China into the US even while levying a tax on exports from the US into China.

Beijing did revalue the currency in July , but by just 2 per cent, far below the 30 per cent revaluation sought by the US.

New tariff protection in the offing?
Seeing the exchange rate as one of the biggest barriers to fair global trade, some American lawmakers are now planning to introduce a Bill in the Senate calling for a tariff of 27.5 per cent on China's exports to the US if Beijing fails to change its currency policy. The figure of 27.5 per cent is, according to the Bill sponsors, the average amount of under-valuation of the Chinese currency.

Such an action can be pursued under Article XXI of the General Agreement of Tariffs and Trade (GATT) 1994, which allows WTO members to take "any action" considered necessary for the protection of its "essential security interests."

Another action that is contemplated by the US authorities is to compensate the domestic industry in the US through a countervailing duty for the amount of Chinese subsidies including the under-valuation of the yuan. Further, one understands that under the arrangements for China's accession to the WTO, a safeguard clause was included to protect the US textile industry in the event of a surge in textile imports.

Washington has already announced imposition of safeguard restrictions on certain categories of textiles imported from China. Clearly, the US lawmakers are in a protectionist and a confrontationist mood against the Chinese who, in direct contrast, are in no mood to listen to the former's diktats. More important, the US feels that once the yuan is revalued, it could pave way for the revaluation of a host of currencies across continents. Consequently, the US feels that the trade deficits held against it by its major trade partners could be addressed and this would, in turn, remedy its burgeoning current account deficit, which at last count was in excess of $800 billion.

Of course, there are contrary views on this strategy proposed by the US. In an article titled China Syndrome, Steve H. Hanke and Michael Connolly point out that the exchange rate of the yuan has been "set in stone at 8.28" since June 1995. Adjusting for inflation in China and the US, they point out that the real value of the yuan has depreciated by just 2.4 per cent during the last decade and consequently, the yuan is in equilibrium in the sense that China's inflation rate has converged to the US rate.

Further, the authors point out that the IMF's most recent Country Report on China concluded that "it is difficult to find persuasive evidence that the yuan is substantially undervalued". Of course, such a protectionist approach, the authors point out, could violate the provisions of the MFN status offered by the US to China under Article I of GATT. Being correct economics, the voice of these authors is in the minority and is, as expected, gagged in the US by "popular politics."

Impact on the WTO regime
What is lost in all this is the fact that the US' huge deficit is due to the global imbalance of consumption and savings. While in the US there seems to be an excess of consumption over savings, it is the other way around for much of the rest of the world; indeed, this is what funds the US deficits. The consumption binge of the US consumers, which is not showing any signs of slowing, is the singular cause of this global imbalance. But the moot question is how long will this arrangement last? From the manner in which the US seeks to address the issue it is quite clear that the situation, if not alarming, is quite serious. More important, it now seeks to address the issue through the WTO route, especially in the context of the forthcoming Hong Kong Ministerial.

The solution, as suggested above, is not as simple as it sounds. In fact, the entire range of issues can have serious repercussions in the Hong Kong ministerial.

The agenda for the ministerial includes negotiations on the three pillars lowering tariffs and improving market access for the industrial goods, technically called as Non Agricultural Market Access (NAMA) issues, agricultural issues as well as opening up of the services sector. The three pillars are subject to intense intra- and inter-discipline negotiations and are expected to form a part of a "single undertaking" in Hong Kong.

Given its huge trade deficits, it is impossible to believe that the US could extend any further concessions in opening up its market, especially through improved access for both industrial and agricultural goods. Consequently, it is reckoned that instead of negotiating on providing improved market access, the US would be singularly focused on the exchange rate mechanisms and its impact on the global trade.

Increasingly it is felt that the US shall take recourse to Article XV of GATT, which says the "exchange rate mechanism should not frustrate the intention of GATT Agreements," to buttress its arguments.

Given this paradigm it would be foolish to assume that the US will take a liberal view at Hong Kong. If Washington takes recourse to such protectionism, developing nations are unlikely to get improved market access, as outlined in the Doha declarations for both agricultural and non-agricultural goods, to the US andother developed countries. The Ministerial could run aground even before it sets sail.

More important, it could mean that, soon enough, an issue that was peripheral to global trade the exchange rate mechanism could come to dominate the WTO regime. This represents a tectonic shift in the assumptions on which the WTO negotiations are founded.

Published at: http://www.thehindubusinessline.com/2005/10/07/stories/2005100700161100.htm

Last modified on Sunday, 07 July 2013 07:36

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