China signals plans for stronger yuan

China signals plans for stronger yuan
June 20, 2010 - 9:11AM

China said it will allow a more flexible yuan, signaling an end to the currency's two-year-old peg to the US dollar a week before a Group of 20 summit.

The decision was made after the world's third-largest economy improved, the central bank said in a statement on its website, without indicating a timeframe for the change. It ruled out a one-time revaluation, saying there is no basis for ``large-scale appreciation,'' and kept the yuan's 0.5 per cent daily trading band unchanged.

``The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability,'' the People's Bank of China said. ``It is desirable to proceed further with reform of the renminbi exchange-rate regime and increase the renminbi exchange-rate flexibility.''

The move may help deflect criticism from President Barack Obama and other G-20 leaders, who have blamed China for relying on an undervalued currency to promote exports. It also affirms Treasury Secretary Timothy F. Geithner's policy of encouraging China to loosen restrictions on the yuan while resisting calls in Congress for trade sanctions. Geithner in April delayed a report to lawmakers assessing whether China or any other country is unfairly manipulating its exchange rate.

``This is another small victory for Tim Geithner,'' Goldman Sachs's Chief Global Economist Jim O'Neill said in an interview with Bloomberg Television in St. Petersburg, Russia.

The Australian dollar is buying about 5.9 yuan. A stronger yuan may slow the Chinese economy as its exports become less competitive in international markets. On the other hand, China is likely to import more, and its currency will make overseas investments by Chinese companies - such as in Australia's resources and property - more attractive.

`China bashing'

``It makes it a lot more difficult for Washington and Congress to do China bashing,'' O'Neill said. ``The Chinese are increasingly confident they can make this adjustment to a domestic-driven economy rather than the one relying on exporting low-value-added stuff to the rest of the world.''

Geithner, in a statement, praised China's decision and added that ``vigorous implementation would make a positive contribution to strong and balanced global growth.'' The Obama administration received advance notice of the announcement, US officials said.

China, by moving on its currency ahead of the G-20 meeting June 26-27 in Toronto, has shifted attention to the budget deficits of developed nations, said Eswar Prasad, a senior fellow at the Brookings Institution in Washington.


``It can now argue that the G-20 leaders should focus on the major determinants of global imbalances, especially the buildup of debt in advanced economies,'' said Prasad, a former head of the China division at the International Monetary Fund. The move ``also serves to acknowledge that they have an important responsibility to the international community.''

Helping exporters

Chinese authorities have prevented the currency from strengthening since July 2008 to help exporters cope with sliding demand triggered by the global financial crisis.

The currency appreciated 21 per cent in the three years after a peg to the US dollar was scrapped in July 2005 and replaced by a managed float against a basket of currencies including the euro and the Japanese yen. The yuan is a denomination of China's currency, the renminbi.

``This move is a vote of confidence in the global recovery and a reaffirmation of Beijing's longstanding commitment to a flexible currency regime,'' Stephen Roach, chairman of Morgan Stanley Asia Ltd., said in an e-mail. ``This shift, however, is not a panacea for an unbalanced global economy. Surplus savers like China still need to take additional actions to stimulate internal private consumption.''

Import costs

Companies focused on the Chinese market, including Beijing-based computer maker Lenovo and Shanghai-based China Eastern Airlines, said in March that they would gain from lower import costs and stronger consumer purchasing power should the yuan appreciate. Textiles makers would stand to lose the most and some would ``face bankruptcy'' with profit margins as low as 3 per cent, Zhang Wei, vice chairman of the China Council for the Promotion of International Trade, said in March.

A more flexible currency would give China more freedom to decide on monetary policy and reduce inflationary pressures by lowering import costs, the World Bank said in a report last week.

China's inflation rate jumped to a 19-month high of 3.1 per cent in May, higher than the government's full-year target of 3 per cent. Central-bank dollar buying has left the nation with $US2.4 trillion in currency reserves, the world's largest holding.

`Crisis mode'

``China has ended its crisis-mode exchange-rate policy as the economy recovers strongly and inflationary pressure continues to build,'' Li Daokui, an adviser on the People's Bank of China's policy board, said in an interview. ``The yuan's future trend depends on the euro's movement, and the trends of other major currencies.''

Yuan 12-month forwards rose the most this year two days ago, gaining 0.5 per cent to 6.7125 per US dollar. The contracts reflect bets the currency will appreciate 1.7 per cent from the spot rate of 6.8262. They had been pricing in appreciation of 3.2 per cent on April 30 before a slump in the euro and a worsening of Europe's debt crisis eased pressure for appreciation.

``The central bank's statement means China's exit from the dollar peg,'' said Zhao Qingming, an analyst in Beijing at China Construction Bank, the nation's second-biggest bank by market value. ``If the euro continues to remain weak, it could also mean that the yuan may depreciate against the dollar.''

Deadline postponed

Geithner postponed an April 15 deadline for a semiannual review of the currency policies of major US trading partners, which might have resulted in China being labeled a currency manipulator. China owned $US900 billion of US Treasuries as of April, the largest foreign holdings.

China's exports jumped 48.5 per cent in May from a year earlier, the biggest gain in more than six years, according to customs bureau data June 10. Exports exceeded imports by $US19.5 billion, from $US1.68 billion in April and a deficit of $US7.24 billion in March that was the first in six years.

China's narrowing balance-of-payments gap indicates that there's no basis for ``large-scale appreciation'' by the yuan, the central bank said in the English version of its statement. The Chinese version said no ``large-scale volatility.''

Twelve of 19 respondents surveyed by Bloomberg in April predicted the central bank would allow the currency to float more freely this quarter, while the rest saw a move by year-end. Eleven ruled out a one-time revaluation, while 15 predicted a wider daily trading range.

``Continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies,'' the statement said. That suggests a looser link to the dollar, said Ben Simpfendorfer, chief China economist at Royal Bank of Scotland Group Plc, in Hong Kong.

``China has to offer something ahead of the G-20,'' he said. ``Greater flexibility allows them the option to appreciate against the dollar, perhaps during periods of dollar weakness.''

Bloomberg News