Magazine article Business Credit

Hot Spots: China

Magazine article Business Credit

Hot Spots: China

Article excerpt

When Beijing announced on JuLy 21 that it had severed the yuan's long-standing direct Link with the U.S. doLlar and would allow the currency to respond more readily to market forces, many observers rushed to the conclusion that the 2.1% revaluation of the unit announced at the time was buta first step in a series that would raise the renminbi's value quickly and decisively. It was not hard to predict that this conclusion would prove false. By now, the financial markets have become resigned to the idea that any further appreciation of the renminbi will come only very slowly, in tiny steps, and will not be nearly enough to make a dent in China's burgeoning exports.

Governor Zhou Xiaochuan of the Bank of China has said repeatedly that the move made in July was more than just a one-off adjustment. He has stressed that "it is very clear that China is introducing a new exchange rate mechanism" that will, over time, pave the way for a free float. But "over time" is the key phrase here. The authorities believe firmly that they must move with deliberation to allow Chinese companies and the public to adapt. Says Mr. Zhou, "They need to learn how to live with the new exchange rate mechanism and familiarize themselves with financial instruments like foreign exchange forwards, and others, to hedge their exchange rate risks."

With a trading band that allows the yuan to float maximally 0.3% up or down on a given day, the exchange rate can at most appreciate by just under 10% over the course of a year. In practice, the rise against the dollar will be further moderated by Central Bank intervention and by the fact that the unit is now pegged to a basket of currencies, so that its movement is being determined by a broad and viscous average of exchange rate movements. The authorities have unveiled the composition of the basket, which includes the currencies of 11 of China's major trading partners. On the list are the U.S. dollar, the Japanese yen, the euro, and the South Korean won, said to be the most heavily weighted, as well as the Singapore dollar, the British pound, the Malaysian ringgit, the Russian ruble, the Australian dollar, the Thai baht, and the Canadian dollar.

Notably absent in the line-up are the Hong Kong dollar and the Taiwanese dollar, but from Beijing's perspective this makes eminent sense, since Hong Kong is already a Special Administrative Region of China and is expected to adopt the yuan eventually as its currency. Taiwan is a "renegade province" that will eventually be "re-integrated" into the PRC as well. What the authorities have continued to keep secret are the individual weights that the currencies in the basket have, and this, of course, makes it virtually impossible to assess what influence certain exchange rate movements will have on the renminbi. Predictable is only that the yuan's daily exchange rate movements will continue to be very small.

Under these circumstances, it will be only a matter of time until pressures from abroad for Beijing to permit a more rapid rise of the yuan will mount again, especially as China is now in the midst of a very rapid expansion of its global foreign trade surplus. The black entry for the first seven months of this year weighed in at USD 49.9 billion, which was not only a dramatic improvement from the first half of last year, when the balance was still in deficit by USD 6. …

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