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DEVELOPMENT: Currency Friction A Test of G-20 Mettle

Analysis by Suvendrini Kakuchi

TOKYO, Nov 8 2010 (IPS) - South Korea’s leadership faces a serious test when it hosts a summit of the Group of 20 advanced and developing economies this month, amid a currency war that is straining relations among its members.

Over the past months, countries from Japan to Thailand to Brazil have nervously watched their currencies appreciate against the U.S. dollar. China has again found itself the subject of calls by the U.S. government and other countries to let its currency, the yuan, appreciate more rapidly to seek its real market value.

But at the same time, developing countries look warily upon the U.S government, especially after the U.S. Federal Reserve’s Nov. 4 decision to buy government bonds in order to pump 600 million dollars into the country’s economy – a move that may send even more speculative capital or ‘hot money’ heading for emerging economies. Asian economies are drawing capital because of their continued growth, expected to reach 9.4 percent in 2010, far ahead of expected growth figures in developed economies. The frictions that arise this financial environment will test the ties that bind the G-20, given member economies’ different and at times competing interests, at the Nov. 11- 12 summit in Seoul, South Korea.

“I do not want to throw cold water on the summit, but the situation is at crisis level,” economist Satoshi Okuda, a South Korea specialist at the Institute of Developing Economies, said in an interview. “Unless Beijing and the United States find a way out to deal with former’s trade surplus and the latter’s trade deficit, there is not going to be real progress.”

Okuda’s remarks point to the larger tussle playing out in the background – U.S. and China tensions – but also the awareness by many developing economies that a mishandling of China’s financial challenges might cause serious instability in the world economy. By 2020, China is set to be the largest trading partner of every single Asian country, says the financial services firm PricewaterhouseCoopers.

Apart from being the world’s largest economy, China’s continued export muscle has seen it acquire trade surpluses. Beijing is resisting international pressure to let the yuan appreciate rapidly, saying this would cause export businesses to suffer and lead to social disruption if millions of workers are laid off.

At the same time, the United States’ public debt stands at 95 percent of Gross Domestic Product (GDP). It is in fact now relying increasingly on foreign creditors, including China, to stay afloat.

While U.S.-China tensions continue, emerging economies are feeling the impact of short-term capital inflows in the appreciation of their currencies and protests from exporters worried about the competitiveness of their products.

In Asia, the Japanese yen has been the currency most affected by appreciation, spiking to a 15-year high against the dollar in August and prompting its central bank to intervene in currency markets for the first time in six years. The Thai baht has risen to a 13-year high against the dollar.

In reaction, countries ranging from Indonesia, Thailand, South Korea have taken a mix of actions to shield their economies from the fallout of excessive capital inflows.

In October, the Thai government put in place a 15 percent withholding tax on foreign bond holders, watching how its currency, hovering at about 29.6 to a dollar, is going because exports account for 65 percent of the country’s GDP. Regulators in South Korea announced an audit of lenders handling currency derivatives in October.

In October, Brazil increased for the second time its financial transaction tax on short-term fund flows and brought it up to 6 percent. Its currency, the real, has appreciated by 12 percent since July.

Japanese Finance Minister Yoshihiko Noda defended intervention to control the yen’s rise. “Japan, which has a current account surplus, may be pressed to allow a further rise in the yen,” the ‘Daily Yomiuri’ newspaper said in a late October editorial, arguing for capital controls.

Questions over how effectively the G-20 can deal with currency tensions at a multilateral level also arise from the fact that although it represents 80 percent of world trade, it is as a non-binding group, unlike more formal negotiation venues.

Formed in 1999 in the wake of the financial crises to give developing economies a greater voice in global economic governance, the G-20 members are Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, Britain, the United States and the European Union.

South Korean President Lee Myung-bak has said he expects the G-20 to take ” a step forward” and “reach a compromise” in creating guidelines for market-rate exchange systems and set “indicative guidelines” to assess current account balances.

Among the proposals being floated ahead of the G20 meeting is the institution of a cap on a country’s current account deficit or surplus at 4 percent of its GDP, to help defuse the currency dispute.

The global currency situation is similar to a dormant volcano, international finance analyst Euh Yoon-dae was quoted as saying in ‘The Korea Herald’ newspaper.

He believes that China could agree to the 4 percent cap and even allow freer movement of the yuan. But then, he said, Japan is unlikely to find this appealing as a competitor, as its manufacturing industry has been struggling to keep its share in international trade.

In short, Okuda points out, the clamour from countries like the United States to contain China’s exports and currency policy must be tempered by the reality that a decline in China’s growth would hurt its capacity to conduct trade with Asia, Latin America and Europe, which these regions badly need in the first place.

Adds Okuda: “Such a scenario is too scary for it will only result in stagnant economic growth in the world.” (ENDS/IPS/AP/IF/WD/DV/SK-JS/JS/10)