wsjonline>Beijing Move Threatens to Shake Up Its Neighbors
By ALEX FRANGOS And NEIL SHAH
HONG KONG—While all eyes will be trained on the Chinese yuan in coming days, China's decision to drop its currency peg is likely to cause bigger reverberations in the rest of Asia.
The South Korean won, Australian dollar, Thai baht and Malaysian ringgit are seen as proxies for China's growth. In 2005, the last time China began a revaluation of its currency, investors threw money into Asia, driving up the currencies there against the U.S. dollar.
"It's possible the bigger currency moves will be in the rest of Asia, not in China," says Robert Subbaraman, economist for Nomura in Hong Kong.
Most analysts and investors interpreted China's announcement as indicating the nation is generally bullish on the world's economy. China indicated it had more confidence in its own growth and that it wasn't troubled by Europe's sovereign-debt woes. That may give an added boost to emerging-markets and commodity-linked currencies like the Australian dollar. Currencies like the euro, which is seen as a riskier asset, may also receive at least a short-term bounce against the U.S. currency.
"It is bullish for risky assets, as the statement signaled China has become more optimistic about the growth outlook," said Jim O'Neill, head of global economics research at Goldman Sachs.
The last time China allowed the yuan to rise—in 2005—the move sent waves throughout financial markets, pushing down the U.S. dollar and driving up Asian currencies.
The South Korean won, for example, rose 10% against the dollar from July 2005 to July 2007, according to Glenn Maguire, Asia economist for Société Générale in Hong Kong. The Australian dollar rose 20%.
This time around, the global financial situation is different. Back then, the world's economy was healthy and China was sucking in raw materials to help build its infrastructure ahead of hosting the Olympics.
Now, the world economy is only just getting back on its feet after the 2008 financial crisis and subsequent recession. China is trying to cool its economy, which many say is in danger of overheating.
The move this time has been long anticipated, which may limit the size of any moves in the foreign-exchange market.
Since hitting post-crisis highs in April, regional currencies have pulled back sharply on fears the euro-zone recovery would falter and that less Chinese bank lending would kill the region's economic growth engine. The Australian dollar is 6.5% below its recent high. The South Korean won is 8% lower than its April high against the dollar of just more than 1100 won.
For many of China's neighbors, the yuan move may prove a double-edged sword.
On the one hand, it will give them breathing space in managing their monetary policy. Rising inflows of capital and demand for energy and other commodities have pushed up inflationary pressures, but central bankers have been loath to raise interest rates for fear of attracting even more capital and pushing currency values higher. Higher currency values made exports—a key driver of Asian growth—less competitive, particularly against China, as long as its currency stood still against the dollar.
Now, with the yuan potentially on the rise, central banks in places such as Thailand, Indonesia and Taiwan may feel more comfortable letting currencies get stronger. That in turn can help fight inflationary pressures because a stronger currency makes imported goods and commodities less expensive, reducing the need to raise interest rates.
At the same time, China's neighbors could soon find themselves with a flood of new capital, forcing them to curb the advances in their currencies.
Investor demand for local currencies may put "more pressure on central banks to intervene to keep currencies from getting too strong," says Peter Redward, head of emerging Asia research for Barclay's Capital in Singapore, who adds, "What's good for China is yet again not necessarily good for the rest of Asia."
While the timing of any change to the Chinese currency this time around is unclear, analysts say China may set the yuan as low as 6.8265, below Friday's 6.8275.
Royal Bank of Canada economist Brian Jackson forecasts the dollar-yuan rate to fall to 6.70 by the end of the second quarter and to 6.50 by the end of this year. Analysts at Nomura predict a rate of 6.65 by year-end and 6.30 by the end of 2011.
China's news could give added impetus to the euro, which has rebounded in recent weeks after falling as low as $1.1876, below its 10-year average of $1.20, earlier this month. The euro could rise as high as $1.25 in coming days if worries about Europe's debt crisis continue ebbing. But most analysts still think the euro will suffer further. Indeed, currency watchers at French bank BNP Paribas SA lowered their euro forecasts late last week and expect to see Europe's common currency fall beneath parity against the dollar, though they are on the bearish side of the analyst spectrum.
Investors are simply waiting for the euro to rise a bit further before renewing their bearish bets against the currency, says one currencies analyst at a London-based hedge fund. "Sooner or later, investors will sell the euro."
—Don Curren
contributed to this article.
Write to Neil Shah at neil.shah@dowjones.com
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