Pressure on China to bring economy down to earth

China will come under renewed pressure at this weekend's Group of Seven meeting in London to ditch its fixed exchange rate regime and instead allow the yuan to float freely on the foreign exchanges.

The country is causing panic among European manufacturers as a flood of Chinese-made clothes and shoes has come into the European Union since import restrictions were ended on January 1. It emerged yesterday that imports of Chinese-made shoes into the EU rose nearly 700% in the first four months of this year.

Chinese finance minister Jin Renqing will attend a breakfast on Saturday with finance ministers of the G7 (Britain, Canada, France, Germany, Italy, Japan and the United States) even though China is not a member. But the country's growing importance in the world economy - it will overtake Britain in size over the next year or so - means it cannot be ignored.

It is far from clear that Mr Jin will be persuaded by any amount of ear-bashing to change the yuan's 10-year-old fixed exchange rate of 8.3 to the dollar. China considers the peg to be a domestic affair and many experts think that pressure from other countries to change or even abandon it could make the Chinese authorities simply dig their heels in further.

While Chinese officials have indicated that it would be desirable at some point to move to some sort of floating currency, they have resisted intense pressure, especially from the United States, to announce an immediate revaluation of the yuan.

US treasury secretary John Snow has long maintained that part of the reason that the US has such an enormous trade deficit is that China is holding its currency artificially low by buying up huge quantities of dollar assets thereby making Chinese exports artificially cheap.

Indeed, Mr Snow has given the Chinese a six-month deadline in which to revalue the yuan, also known as the renminbi. Failing that, Congress is preparing to slap tariffs on Chinese imports.

US Federal Reserve chief Alan Greenspan piled on the pressure on Tuesday, telling a conference in Beijing: "The issue of allowing flexibility in some form in the [renminbi] strikes me as very much to the advantage of China and indeed it is something that I am certain they will take on reasonably soon."

His opposite number at the People's Bank of China, Zhou Xiaochuan, played down expectations of any imminent move, saying it could only happen as part of a wider set of economic reforms to ensure the country's economy could safely adjust to a floating currency. Political pressure from other countries would not help, he said.

"This is not a favourable environment for China to put forward its reform and for its decision-making process," he said, adding that each stage of the reform process would be consulted on with different groups in the country.

Chinese premier Wen Jiabao made the position crystal clear last month: "Reform of the renminbi's exchange rate is a matter of China's own sovereignty. Any pressure or media play-up will not help solve problems."

Nevertheless, financial markets across the globe are abuzz with speculation that the Chinese could be saying all this to keep any revaluation under wraps until it actually happens. Some economists expect some sort of change before Chinese president Hu Jintao attends the full Group of Eight (G7 plus Russia) meeting in Gleneagles in early July. That could be a small revaluation linking the renminbi to a basket of currencies rather than just the dollar, or even a larger revaluation.

Janet Henry, senior global economist at HSBC, warns against great expectations of any move from the Chinese.

"Our assumption remains that the Chinese authorities will focus primarily on domestic financial reform, with only limited changes likely to the exchange rate regime in the coming months."

The most plausible options for the Chinese would be either changing to a peg against a basket of currencies or allowing a "crawling" peg against the dollar - whereby the exchange rate would be altered periodically and gradually.

With the economy already slowing, although still growing strongly, the Chinese authorities will be keen to avoid a large revaluation for fear of the impact of a drop in the competitiveness of the country's exports, Ms Henry says.

The Chinese economy has been growing at an annual rate of 10% or more for many years, sucking in raw materials from around the world and pushing up commodity prices to record levels. Gleaming new skyscrapers in places such as Shanghai have sprung up as a result of a construction boom.

Irritation is growing in the west about the surge in exports of Chinese textiles and shoes this year since the quota regimes were phased out.

Yesterday's figures from the European commission showed imports of Chinese shoes into the EU in the first four months of the year were up 681% from the same period last year, to 162m pairs. The average price per pair was €2.4 - that is £1.61, a tenth of the price of the average pair of shoes exported by Italy.

The EU is about to slap temporary emergency quotas on imports of Chinese T-shirts and flax yarn if China does not voluntarily rein in exports, something the Chinese agreed to do when they joined the World Trade Organisation in 2001.

Brussels said yesterday that trade commissioner Peter Mandelson may travel to Beijing on Friday to see if he can clinch a deal on Chinese textile exports. The issue of surging shoe exports is also likely to be on the agenda.