he US Treasury reiterated that China's currency is undervalued in its semiannual report, but declined to label China a currency manipulator. But the report also had surprising criticism of Japan's efforts to limit the yen's appreciation. In other economic news, Japan has sealed a currency swap deal with India worth US$15 billion. Meanwhile, borrowing rates on some Italian government-issued debt have dropped by half, a positive sign for the euro area.
Value of the Yuan
The latest Semi-Annual Report to the Congress on International Economic and Exchange Rate Policies highlighted the need for greater exchange rate flexibility, in China and also in other major economies.
The report was previously delayed by the US Treasury, in the hopes of using global summits in the last few months of the year as leverage to persuade China to let the yuan appreciate more quickly.
In the report, the US Treasury concluded that China did not meet the standards of a currency manipulator, "Based on the ongoing appreciation of the RMB against the dollar since June 2010, the decline in China's current account surplus, and China's official commitments at the G-20, APEC, and the U.S.-China Strategic and Economic Dialogue (S&ED) that it will move more rapidly toward exchange rate flexibility".
However the department said that "While China's real exchange rate has appreciated the process of appreciation remains incomplete". It noted the "real exchange rate of the renminbi is persistently misaligned and remains substantially undervalued".
The report added that the US Treasury would continue to "press for policy changes that yield greater exchange rate flexibility, a level playing field, and a sustained shift to domestic demand-led growth".
Criticism of Japan
The US Treasury report also contained the most direct US criticism yet of Japanese policy. The report said "rather than reacting to domestic 'strong yen' concerns by intervening to try to influence the exchange rate, Japan should take fundamental and thoroughgoing steps to increase the dynamism of the domestic economy, increase the competitiveness of Japanese firms—including those in utilities and services—and raise potential growth".
The US and other G7 nations joined Japan in a yen intervention after the March 11 earthquake. But the US declined to back Japan's two latest moves, saying the currency should be based on market fundamentals.
Analysts say that although it was known the US did not approve of Japan's measures, the strong US message was still a surprise and will make it more difficult for Tokyo to try and weaken the yen again.
Report: U.S. Criticizes Japan, China on Currencies [Wall Street Journal, 28 Dec 2011]
Report: U.S. Treasury declines to name China as currency manipulator [Xinhua, 27 Dec 2011]
Japan and India Currency Swap Deal
Meanwhile, Japan has agreed to make US$15 billion available to India in a currency swap arrangement as Europe’s deepening debt crisis threatens to curtail developing Asia’s access to dollar funding.
In a joint statement with Indian Prime Minister Manmohan Singh, Japanese Prime Minister Yoshihiko Noda said: "Amid global economic uncertainties, ensuring the stability of the financial markets is all the more important for the stable economic development of the two countries".
A previous US$3 billion dollar to local currency arrangement between the two countries expired in June. The troubled Indian rupee was Asia's worst-performing currency this year. The currency swaps are expected to support the Indian rupee as it continues to weaken against the greenback and Europe's sovereign debt crisis hits India's exports.
Mr. Noda was on a one-day trip to India to boost financial cooperation between Asia's second- and third-largest economies. Japan and India are also working more closely on security issues and seeking a deal to allow India access to Japan's civil nuclear technology.
Earlier, he called for greater Indo-Japanese economic relations, after India's trade minister said bilateral commerce would only reach US$25 billion by 2014. Despite the low trade volume, Japanese companies are increasingly viewing India as a long-term partner.
Mr. Noda said Japan would invest US$4.5 billion in a 1,483 km industrial corridor stretching from New Delhi to the financial hub of Mumbai in the west. He also promised loans in yen worth US$1.7 billion for two projects, including expanding Delhi's metro railway.
The joint statement also said talks on civil nuclear sales were going "in the right direction" and that progress was made on Wednesday.
In an effort to take advantage of the yen hovering near a record-high against the dollar, Japanese officials have prepared 10 trillion yen (US$129 billion) in a fund for companies to pursue more overseas acquisitions.
Meanwhile, Japan has pursued currency-swap accords with other nations, including one with South Korea that it expanded to US$70 billion in October. Japan also has bilateral swap deals with Indonesia, the Philippines and China.
This month, Japan also reached a deal with China to expand use of the yuan and yen in bilateral trade and purchase Chinese bonds.
Report: India, Japan agree $15 billion currency swap as rupee swoons [Reuters, 28 Dec 2011]
Report: Japan, India Seal $15 Billion Currency Deal [Bloomberg, 28 Dec 2011]
According to a Bloomberg editorial, recent Asian financial deals have significant long-term implications. The currency swap deal between Japan and China is part of China's strategy to seek a bigger role for its currency in global markets. China wants power in international forums that is commensurate with its economic might. The sooner its currency is fully convertible and its economy is open to global investment, the sooner this will happen.
The yuan is thus on its way to becoming a global reserve currency alongside the dollar, yen and euro. Bloomberg's editors believe this would ultimately have benefits for all parties - a fully internationalized yuan would be free to appreciate. China’s trade surplus, a destabilizing force in the world economy, would then be self-correcting, and the friction in US-China economic diplomacy would subside.
Analysis: China-Japan Currency Deal Points Way to a New World Monetary Order: View[Bloomberg, 29 Dec 2011]
Italian Borrowing Costs Fall
The cost of borrowing faced by the Italian government has fallen sharply at its latest debt auction. The government raised €9 billion (US$11.8 billion) in short-term debt at half its previous interest rate.
The interest on the six-month bills was 3.251 percent, down from 6.504 percent at the last similar auction in November.
Market analysts said the drop on borrowing rates on Wednesday partly reflected Italian bond purchases by the European Central Bank and other European banks. The auction follows the extension of €489 billion euros in three-year loans to eurozone banks by the European Central Bank (ECB) last week.
But analysts said a bigger test for Italy would come in a larger bond auction on Thursday.
Italy, the euro area’s third-largest economy, must refinance almost €200 billion in government debt by April. If borrowing rates remain high, the country could face a solvency crisis and potential default that could threaten the stability of the joint currency.
Report: Italy borrowing costs fall sharply at auction [BBC, 28 Dec 2011]
Report: Italy’s Debt Cost Dips, but Its Economic Perils Remain [New York Times, 28 Dec 2011]