By  on December 27, 2011

The U.S. Treasury Department, in its semiannual report on international economic and exchange rate policies of America’s major trading partners, said China has made enough progress in reforming its currency that it will not recommend it be declared a currency manipulator.

Such an action could have led to punitive actions and heated up an already fragile economic relationship between the world’s two largest economies.

However, the Treasury report stated, “While China’s real exchange rate has appreciated, the process of appreciation remains incomplete. China’s long-standing pattern of reserve accumulation, the persistence of its current account surplus and the incomplete appreciation of the renminbi, especially given rapid productivity growth in the traded goods sector, indicate that the real exchange rate of the renminbi is persistently misaligned and remains substantially undervalued. It is in China’s interest to allow the exchange rate to continue to appreciate, both against the dollar and against the currencies of its other major trading partners.”

The report noted that the Chinese government has identified shifting away from growth driven by exports toward a greater reliance on domestic consumption as a critical goal for sustaining growth in the medium term. At the G20 Leaders Summit in November, G20 members, including China, committed to “move more rapidly toward more market-determined exchange rate systems and enhance exchange rate flexibility to reflect underlying economic fundamentals, avoid persistent exchange rate misalignments and refrain from competitive devaluation of currencies.” China also stated that its rebalancing actions “will be reinforced by ongoing measures to promote greater exchange rate flexibility to better reflect underlying economic fundamentals and gradually reduce the pace of accumulation of foreign reserves.”

Since the Chinese authorities decided in June 2010 to allow the exchange rate to appreciate, the renminbi has appreciated 7.5 percent against the dollar as of Dec. 16. Taking into account the higher rate of domestic inflation in China than the U.S., the renminbi, or yuan, has appreciated against the dollar on a real, inflation-adjusted basis of nearly 12 percent since June 2010 and nearly 40 percent since China first initiated currency reform in 2005, said the report.

Treasury did note that it will continue to closely monitor the pace of China’s currency appreciation and press for policy changes that yield greater exchange rate flexibility, level the playing field and support a pronounced and sustained shift to domestic-demand-led growth. U.S. textile manufacturers and some politicians have said China undervalues its currency, leading to unfairly priced exports.

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