So far, all that China has done is relax the yuan?s peg to the dollar. It is still pegged, but to a basket, and not exclusively to the dollar. At one level, dismantling the dollar peg signifies that the worst of the global financial crisis is over, since the dollar peg was introduced in 2008 to cushion Chinese exporters from those effects. We are back to the basket peg of 2005. China has consistently faced criticism because of undervaluation of its currency and this has been linked to its large trade account surpluses. The timing of the announcement is not a coincidence. It reduces flak at the G-20 meeting, suggests China is flexible and for what it is worth, underlines the need for reforming global financial institutions and architecture. The Chinese dilemma isn?t different from India?s. It is the quantum that is different. Undervaluation is good for exports, especially if exports are low down the value chain and price-sensitive. But if the exchange rate is left to the markets, currency will appreciate and there can be tensions between what trade (or current) account ostensibly requires and what capital inflows do. So, as a central bank buys foreign exchange to prevent appreciation; it increases liquidity and has an adverse effect on inflation because imports become more expensive.

Following the announcement, the yuan has appreciated against the dollar and a lot is being made of this flexibility in currency regimes. Apart from China being seen to be more ?sensible?, handling inflation now becomes easier. Exporters focus on efficiency and become more competitive. Instead of depending on exports alone, one looks for endogenous sources of growth. In principle, this is fine. Ceteris paribus, it is good news for India. When India and China compete in similar export markets, and that competition is based on price, our exports become cheaper. And this argument can be extended to bilateral trade, where our current export basket is so narrow that a negative balance on merchandise trade is inevitable. However, one should be careful with such blanket pronouncements. Value of the yuan won?t be determined in the market. All that has happened is a transition from a dollar peg to a basket peg. Even if there is more flexibility, there will be central bank intervention. As far as one can make out, there will still be a band with a narrow daily range and an attempt to delink medium-term trends from what is perceived to be ?volatility?, an attempt not unfamiliar in India.

Apart from G-20, China wished to fend off flak because exchange rate determination was a thorn in US-China trade negotiations. There is no denying that the yuan has become a bit more flexible. But, given China?s manufacturing engine, it is doubtful that the balance of trade surpluses with other countries will disappear. They may become a bit less. Consequently, it is hardly the case that protectionism (there is no other word for it) in developed countries will disappear. Instead of exchange rates, we will move on to standards, anti-dumping, anti-subsidy investigations and labour and environmental standards. Several instruments are available. Given China?s size (economy and exports) and strengths in manufacturing, it has been more of a target than India. It is not that India has not been targeted; targeting has primarily been restricted to services, particularly IT. Apparently, China is going to confront an ageing population soon and we will continue to have a demographic dividend window until 2040. Suggestions float around that by 2020 (or earlier if some government sources are to be believed), India?s GDP growth will overtake China?s. For that to happen, both manufacturing and exports have to take off on a larger scale than before.

If this optimistic scenario emerges, India will face protectionism. When an economy does well, one can?t prevent exchange rate appreciation. Most people vaguely remember the first Bric (Goldman Sachs) report. They don?t remember roughly one-third of that explosive (especially beyond 2020) increase in per capita incomes (expressed in US dollars) came from currency appreciation. In other words, we had better learn to live with an appreciating rupee and more flexible exchange rate management. It is a myth that the rupee?s value is market-determined today. But that myth has to increasingly become a reality. At one time, not so far in the distant past, RBI evidently had a band of sorts. And medium-term appreciation was allowed, after de-linking volatility from secular trends, assuming one can de-link the two. It was also believed (no doubt wrongly) that this ?permitted? appreciation amounted to 10 paise a month, against the dollar. Imparting certainty to exchange rates and cushioning volatility also encourages exporters and importers not to hedge. This can?t be desirable either and much of this new uncertainty among traders is because certainty (which shouldn?t have been there in the first place) has disappeared. It is good to think of an exchange rate of 30 rupees to a dollar, time period unspecified.

The author is a noted economist