The first step for yuan
Indonesian exports will not benefit much from China's move last week to scrap the yuan's 10-year-old peg to the American dollar and revalue it by 2 percent to 8.11 to the dollar.
It needs much more than a 2 percent increase in the costs of China's goods to significantly erode their international competitiveness against Indonesian exports, which still suffer severely from our high-cost economy.
However, China's foreign-exchange move, albeit a minor one, is a very significant step on a long path towards a true float and open capital account regime, which will especially benefit other countries in East Asia.
The immediate impact will be rather insignificant because what China launched last Thursday was only a shift from a fixed peg to a strictly managed float. Moreover, China's central bank immediately announced that the tightly-managed float system will only allow the yuan to appreciate or depreciate against the dollar by maximum 0.3 percent on any trading day.
This means that the yuan is not yet fully exposed to market forces, with China maintaining its system of foreign-exchange control over money flowing into and out of that country.
China apparently has drawn a great lesson from the bitter experiences of other developing countries such as Indonesia, which fully liberalized its capital account before its financial service industry was sound and strong enough, thereby putting its financial system at the mercy of volatility in the international financial markets.
As China has already experienced the importance of a stable exchange rate for its robust economic growth over the last decade, it will most likely maintain the yuan rate very close to 8.11 to the dollar at least for the rest of the year.
Scrapping the yuan's hard peg to the dollar will help stave off U.S. pressures for a substantial yuan revaluation, but a strictly-managed float would still allow China to continue enjoying the benefits of a fairly stable currency.
China kept traders in the dark about the content of the basket exchange-rate regime to discourage currency traders from making speculative attacks on the yuan so that it could manage the new system in a more stable environment.
But most analysts have foreseen an increasingly important role of the euro in view of the significant rise in China's trade with Europe, and China apparently wants to gradually switch to a more reliable store of value and unit of account. One alternative is a currency basket reflecting the pattern of its trade. China already trades more with the European Union and Japan than with the U.S.
China's foreign exchange move, though small in its immediate impact on other Asian economies, will allow China to gradually unleash more market forces to manage its economy. Previously, the People's Bank of China was often forced to buy vast amounts of American treasury securities to prevent the yuan from rising against the dollar.
By moving only gradually to a free float and open capital account regime, China's economy would be spared a shock that would otherwise occur if drastic changes were made suddenly. Such a relatively stable environment is also good for other countries in East Asia, including Indonesia, which have developed wider economic linkages with China.
Many economists have long argued that as China gets richer it needs to allow its real exchange rate to rise, in order to reap the full gains of its economic gains. A stronger exchange rate will boost consumer purchasing power by allowing them to buy more foreign goods. At present, China's growth is too dependent on exports, while consumption is weak.
China, however, needs first to establish the credibility of its new basket exchange-rate system, otherwise market expectations of further revaluations would become stronger and this would in turn lure more short-term foreign capital to speculate on a stronger yuan.
It is precisely because of this need to learn how the new basket exchange-rate regime will work in practice that China's central bank seems to prefer a relatively stable rate for the next five months.