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Chinese Prime Minister Zhu Rongji approached Hong Kong officials to seek advice on the potential impact of greater flexibility in the valuation of the yuan and a possible devaluation. Of course, officials in Hong Kong are quite interested in the impact of changes in China’s exchange-rate regime. Nonetheless, recent steps taken to strengthen the currency board set up under the Hong Kong Monetary Authority will limit the disruptive effect on the local currency.

When it comes to policy on the international value of the yuan, there are various camps. There are those who anticipate devaluation of yuan with a sense of dread concerning its impact on regional stability, while others despair about the delay of the inevitable.

These concerns arise from the fact that economic realities seem to fly in the face of the frequent denials issued by Chinese officials that they have no plans to change the de facto peg with the U.S. dollar. Despite wide fluctuations in black market values on dollars traded in Shanghai, the yuan has remained within a narrow trading range since its last official devaluation.

The Chinese economy has been buffeted by a combination of events that normally lead to a fall in the exchange value of a currency. In terms of its international sector, export growth fell while import growth rose. Foreign capital inflows were also slowing while interest rates were forced lower. Meanwhile, comparative advantage in a number of key industrial sectors was undermined because other currencies in the region remain undervalued.

In terms of the domestic sector, deflationary pressures continue with lower household consumption leading to rising inventories among producers. Fixed asset investment remains principally the domain of government spending on infrastructure projects, many of which seem to crumble as rapidly as they are built. When the domestic and international sectors are considered together, recent reports of recovering growth are hardly believable.

Yet many observers seemed to have missed the point that China has already effectively devalued its currency with minimal consequences on its neighbors. This has occurred through some clever maneuvering by the authorities in Beijing.

China took steps in 1998 and 1999 to increase export subsidies that reduced costs for exporters. These have been mostly in the form of tax rebates on export-oriented products. According to the official Xinhua news agency, tax rebates were raised an average of 2.95 percent. Rebates on finished garments destined for export were raised to 17 percent and textile raw materials were raised to 15 percent.

Since China’s official value-added tax on exports is 17 percent, this most recent hike in tax rebates brings more export goods close to having a full tax-refund. Thus, Chinese exporters can lower the price of goods sold in foreign markets.

Previous directives provided exemptions on machinery and equipment, electric appliances and electronic products, transport vehicles, and instruments and meters. More recently, rebates on export duties were raised for aluminum, lead and zinc sold by state-run enterprises.

As such, these actions constitute a stealth devaluation that has allowed at least some Chinese products to recoup some of their lost competitive edge in pricing. Accepted estimates are that an increase in the average export tax rebate of about 3 percent is equivalent to a devaluation of 1.5 percent. So it is not surprising that there has been some turnaround in China’s export numbers, adding to its growing surplus.

Chinese leaders have made the best of their charade of holding their currency steady while accepting praise for behaving as good neighbors by not setting off a chain of competitive devaluations. This sort of deception raises questions about whether China would be a reliable partner if allowed into the World Trade Organization. But then most of its trading partners willfully overlook Beijing’s misleading claims.

So observers in Hong Kong or elsewhere who are concerned about the timing and impact of devaluation by China can rest easy. Those who risked their reputations on predictions of an inevitable devaluation have been right while being proven wrong. Those who dreaded the prospects of a new round of turmoil in Asian currency markets can turn their attention elsewhere. The deed has been done and little notice was taken.

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