China Gives Currency More Freedom With New Reform

April 14, 2012 at 16:10

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China took a milestone step in turning the yuan into a global currency on Saturday by doubling the size of its trading band against the dollar, pushing through a crucial reform that further liberalizes its nascent financial markets.

The People’s Bank of China said it would allow the yuan to rise or fall 1 percent from a mid-point every day, effective Monday, compared with its previous 0.5 percent limit.

Analysts said the timing of the move underlines Beijing’s belief that the yuan is near its equilibrium level and that China’s economy, although cooling, is sturdy enough to handle important, long-promised, structural reforms.

The move could also help China deflect criticism of its currency policy ahead of the annual spring meeting of the International Monetary Fund in Washington next week.

A slowing world economy that has pared investor expectations of a steadily rising yuan likely also gave Beijing the confidence to proceed, knowing that a larger band would not necessarily lead to a stronger currency.

“The central bank chose a good time window to enlarge the trading band. The market’s expectation for a stronger yuan is weakening,” said Dong Xian’an, chief economist at Peking First Advisory in Beijing. “The move partially clears away doubts on whether China can manage a soft landing in its economy, and makes clear China’s reform roadmap.”

Investors have widely expected China to widen the yuan’s trading band this year, thanks to repeated hints from Beijing that the change would take China one step closer to its financial goal: a basically convertible yuan by 2015.

Having a currency that trades with fewer restrictions also enhances Shanghai’s status as a financial center. China envisions turning the city into a global banking hub by 2020.

“From April 16, 2012, the renminbi exchange rate against the dollar in the spot interbank currency market will be widened from 0.5 percent to 1 percent,” the People’s Bank of China said in a short statement on its website.

“China’s foreign exchange market is maturing. The market’s ability to price and manage risks is growing,” the bank said.

Lan Shen, an economist at Standard Chartered Bank in Shanghai, said given that the yuan was estimated to be close to its equilibrium level, the currency was likely to gain only 1.4 percent against the dollar this year.

The yuan, which hit a record high of 6.2884 against the dollar on Feb 10, is little changed against the U.S. currency for the year, softening 0.14 percent since January.

The yuan rallied by about 5 percent in 2011 and nearly 4 percent in 2010, giving economists and markets the impression that Beijing was comfortable with a steadily appreciating currency. It has gained about 30 percent in nominal terms against the U.S. dollar since the landmark move in the summer of 2005 to de-peg the yuan from the greenback.

Premier Wen Jiabao and Central Bank Governor Zhou Xiaochuan both said in March conditions were ripe for the yuan to float more freely to better reflect market demand and supply.

Their repeated calls for reforms came even as China is set to confront its slowest economic growth in a decade this year, leading many to believe Beijing is ready to tolerate less heady growth in exchange for a restructured economy that is driven more by domestic than export demand and has greater flexibility to withstand fallout from external economic shocks.

Some analysts say a more flexible yuan, also known as the renminbi, works in China’s favour in turbulent times as it gives it more room to guide the currency lower to aid exports.

“The message of this move is that RMB’s appreciation story is over. Greater two-way volatility will be the name of the game going forward,” said Qu Hongbin, an economist at HSBC.

Data showed on Friday that China’s economy suffered its weakest growth since the global financial crisis in the first quarter by expanding just 8.1 percent, below forecasts for 8.3 percent.

The last time China changed its currency policy was in June 2010, after a two-year period in which the yuan had effectively been re-pegged to the dollar to help shield China from the 2008-09 global financial crisis.

The yuan’s value has always been a point of contention between China and its trading partners, notably the United States, which say China suppresses the currency to boost exports. China has repeatedly rejected the accusation.

Instead, Chinese leaders say the yuan is near its equilibrium level and that authorities aim to keep its value “basically stable,” more flexibility notwithstanding.

“I think the step should be welcomed by foreign countries, especially the United States, which have been calling for reforms. This is also related to growing domestic calls for economic reforms,” said Dongming Xie, China economist at OCBC Bank in Singapore.