Analysis by Antoaneta Bezlova

BEIJING, Jun 27 2005 (IPS) — Despite repeated calls by the United States and other western powers for an upward revaluation of the Chinese currency, the yuan, Beijing has refused to budge on its stance that the currency is a matter of national sovereignty – meaning that increased pressure from abroad is likely to provoke greater resistance to change.

But behind the defiance, Beijing is preparing the financial system for amore flexible currency system that would allow the yuan to fluctuate within a wider band, and is trying to instil a sense of greater urgency in these preparations.

Since 1994, China has fixed the yuan at about 8.28 to one U.S. dollar, intervening to prevent any large fluctuation.

Ironically, Beijing’s readiness to act on the currency front comes just as many in the United States are beginning to realise that while calls to revalue the yuan have a strong populist appeal, revaluation would have only a limited effect on the U.S. trade deficit with China, valued at 160 billion dollars.

U.S. Federal Reserve Chairman Alan Greenspan warned Congress last week that a rush to impose punitive tariffs on imports from China would harm U.S. consumers and protect "few, if any American jobs".

U.S. manufacturers contend the Chinese currency is undervalued by as much as 40 percent, making the country’s goods cheaper in the U.S. market and U.S. products more expensive in China. Some lawmakers have forwarded a proposal to impose hefty 27.5 percent tariffs on imported Chinese goods if Beijing does not move to a more flexible currency system.

Greeenspan rebuked the currency-related legislation, which has gathered support from two-thirds of the U.S. Senate, saying it would harm the U.S. economy by driving up prices for imported goods.

According to former U.S. senator, democrat Bob Kerrey, understanding is growing in the United States that forcing a Chinese currency revaluation will not be a panacea for U.S. economic pains.

"I don’t think we have responded adequately to globalisation and the consequence is social insecurity that translates into fear from economies like China’s," Kerrey told media at a press briefing in Beijing last week.

For China, this and Greenspan’s warning justify the government’s intransigence on the currency. Chinese economists have long agreed the United States has little to gain economically from a higher ‘renminbi’ (yuan), either in terms of protecting its manufacturing industries or reducing its current account deficit, which they argue is a legacy of U.S. consumers piling up debt to finance consumption now.

To Beijing, therefore, U.S. pressure stems more from the need to find a scapegoat for what are largely self-inflicted economic wounds than from the "currency manipulation" of which China is often accused.

This is why there is more than a tinge of self-righteousness in Beijing’s refusal to cave in to U.S. demands. Time and again, Chinese leaders have insisted that revaluing the currency is a sovereign matter and that pressure "will not help solve the matter".

People’s Bank of China Governor Zhou Xiaochuan said last weekend in Switzerland, where he attended a central bankers’ meeting, that "the time is not ripe yet" to scrap the yuan’s decade-old peg to the dollar.

While Washington is concerned about the short-term outlook, Beijing has to manage long-term risks. The Chinese leadership has to deal with major domestic issues, including bad debts in the banking sector, the big divide between rich coastal provinces and the poor rural hinterland, growing unemployment, controlling inflation and the conversion of state industries into more efficient enterprises.

The authorities fear that any significant move on the currency front could trigger a wave of money flooding into the country, fuelling inflation and sending stock markets into an uncontrollable spin.

If the scale of any revaluation is too great, China risks pricing domestic companies, many of which operate on razor-thin margins, out of the market. The National Bureau of Statistics has estimated that a 15 percent revaluation could turn export growth negative this year. A 3 to 5 percent revaluation would slow export growth to less than 10 percent in 2005 from 35 percent last year.

Such changes would surely result in such potentially serious consequences as unemployment and even social unrest. Another painful side-effect could be the bursting of China’s real estate bubble by ending flows of speculative money into the national property market.

Millions, even billions of dollars of foreign speculative funds have poured into China in anticipation of windfall profits that will accompany an eventual revaluation. Some pundits have predicted a spectacular adjustment of up to 25 percent.

But most China experts predict an initial change of between 3 and 5 percent by the end of 2005. Even here, though, the battleground is fraught with danger. Foreign investors may see a small adjustment in the currency as a precursor to an even bigger move, bringing more speculative foreign capital to China and increasing the risks.

Others say that the government will introduce a basket-based system of currencies and allow the renminbi to rise against the dollar just 1-2 percent initially, thus allowing the country to continue reaping the benefits of its strong trade performance.

Whatever the chosen path, China’s leaders appear to have concluded that renminbi revaluation is a contingency. More and more economists have raised voices in support of currency adjustment, arguing the country has "already lost its best opportunity to revalue".

"The economic and social price of yuan revaluation is climbing higher by the day," senior economist Liang Hong wrote in the ‘China Economic Times’, which is published by the State Council, or China’s Cabinet. "As more ‘hot money’ flows into the country and the trade surplus grows worse, our task at hand becomes more complicated."

Giving plausibility to speculations that a more flexible currency mechanism is forthcoming, the Chinese Foreign Ministry said last week that president Hu Jintao might discuss the exchange rate when he meets with leaders of the Group of 8 (G8) leading industrialised nations in Gleneagles, Scotland Jul. 6-8.

But Premier Wen Jiabao warned that revaluation was not imminent and that Beijing needed more time to prepare the country’s financial system for possible shock effects from the exchange rate reform.