China Loosens Yuan Peg, Shifts to Currency Basket (Update1)
China Loosens Yuan Peg, Shifts to Currency Basket
July 21 (Bloomberg) -- China loosened its fixed-exchange rate against the dollar for the first time in a decade, letting the yuan fluctuate versus a basket of currencies, the People's Bank of China said on its Web site.
Valuing the yuan against more than one currency will allow it to appreciate or decline as the dollar gains or drops versus other currencies. Until now, it has been pegged at about 8.3 per dollar, earning criticism from U.S. Treasury Secretary John Snow, Federal Reserve Chairman Alan Greenspan, German Finance Minister Hans Eichel and his Japanese counterpart, Sadakazu Tanigaki.
``This will be a small, but symbolic first step in a long road,'' said Marios Maratheftis, a currency strategist in London at Standard Chartered Plc, a U.K. bank that gets two-thirds of its profit from Asia. ``If there is any flexibility allowed, and until there has been none, then the yuan will strengthen against the dollar. It won't be a huge move, though.'' He spoke in an interview on June 24.
Letting the yuan strengthen may help President Hu Jintao control inflation by reducing the cost of imported products such as oil and copper, which are priced in dollars. It also gives the central bank, which has sold yuan to prevent the currency from appreciating, more scope to increase interest rates to cool an economy that expanded 9.5 percent in the first quarter.
From 7 p.m., China time, the yuan will be valued at 8.1 per dollar. The yen gained against the dollar after China's decision, strengthening to 111.81. The Singapore dollar also gained and Treasury notes declined.
``Without moving the exchange rate, it looks like the Chinese authorities are struggling to slow the economy,'' said Jim O'Neill, head of global economic research at Goldman Sachs Group Inc. in London. ``The only way to deal with that and get better control over monetary policy is to change the currency regime.'' O'Neill, who spoke in an interview last month, has predicted for a year that a yuan shift may come at any time.
Pressure From U.S.
Permitting the yuan to trade more freely would also answer criticism from the Bush administration and some members of the U.S. Congress that blame China's currency policy for a record trade deficit and the loss of 2.8 million manufacturing jobs.
The Treasury Department's twice-yearly review of exchange rate policies said last month that China needs to make the yuan more flexible or risk being branded a currency manipulator.
``China is now ready and should move without delay in a manner and magnitude that is sufficiently reflective of underlying market conditions,'' Snow told the Senate Finance Committee in Washington on June 23. ``Implementation of trade sanctions would lead to retaliatory policies against our exports, damaging the U.S. and global economy.''
The U.S. trade gap with China rose to a record $162 billion last year and the National Association of Manufacturers, a lobby group, expects it to grow to $225 billion this year.
Indiana Democratic Senator Evan Bayh and Maine Republican Senator Susan Collins presented legislation on June 23 that would let companies petition for duties on Chinese goods to compensate for government subsidies. The bill is one of more than a half- dozen in Congress that address what some lawmakers call China's unfair trade practices.
Currency Basket
Linking the yuan to a basket of currencies means China's currency wouldn't be tied so closely to swings in the dollar, said Adam Cole, a currency strategist at RBC Capital Markets Ltd. in London. The basket will probably be composed of the euro, yen and other Asian currencies as well as the dollar, he said in an interview on June 24.
``For instance, if we went through a prolonged period of dollar downward pressure then the yuan would feel all the pressure of that, but if it was using basket, then the move would be offset by other currencies doing better,'' said Cole. ``It's an easier way to manage a currency target.''
Singapore manages its currency by allowing it to fluctuate against a group of the nation's major trading partners. The Monetary Authority of Singapore, which reviews its policy every six months, hasn't disclosed the composition of the basket.
`One Clear Direction'
Investors have bet on a change in China's currency since 2002.
``If you let the exchange rate become more flexible, there is one clear direction it's going,'' said Marvin Barth, a currency strategist in London at Citigroup Inc., the world's largest bank. He spoke in an interview last month.
China's $1.6 trillion economy, which accounted for a 10th of world growth last year, has trebled in size since the yuan peg was introduced. Foreign direct investment jumped 14 percent to a record $60.6 billion in 2004, according to government figures. A year earlier, China surpassed the U.S. as the biggest recipient.
The People's Bank of China has to buy dollars that flow into the country to maintain the currency peg, adding yuan to the economy and diluting the impact of state lending curbs. The central bank spent $193 billion buying foreign currency in 2004, a 41 percent increase from a year earlier, it said on Feb. 28.
Interest Rates, Inflation
The central bank raised its lending and deposit rates on Oct. 28, the first increase in a decade, to complement limits on investment in property, steel and autos that have driven prices higher and strained power supplies.
``Clearly, it will be more effective if you combine currency and interest-rate policies,'' Uwe Parpart, Bank of America Corp.'s senior market strategist in Hong Kong, said before today's announcement. ``China wants to slow down inflation and growth. Raising rates and the value of the currency both push things in that direction.'' He predicted China would change the peg in the second half.
China is seeking to cap inflation at 4 percent this year from a peak of 5.3 percent in August. Inflation in 2005 is likely to slow to between 3.0 percent and 3.5 percent, the People's Bank of China said on June 14. The consumer price index climbed 1.8 percent in May from a year earlier, the National Bureau of Statistics said on June 13.
To contact the reporter on this story: Yumi Kuramitsu in Hong Kong ykuramitsu@bloomberg.net
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