The future movements of the Chinese yuan have been one of the most hotly debated issues in the global economy for many years. The initial 2.1% revaluation of July 21, 2005, after a decade at CNY8.28/US$, was almost as eagerly awaited as the release of the first Star Wars prequel, and like the latter, it was a huge disappointment. Eventually, the yuan rose by around 22% against the US dollar until the summer of 2008 (and the subsequent Star Wars prequels made up for the initial letdown), when it was re-pegged at CNY6.83/US$. Simply put, with the onset of the 2008-2009 global recession, China saw no reason to let the currency rise, especially with exports declining at a double-digit pace. However, over the weekend of 19-20 June 2010, the People’s Bank of China (PBoC) announced changes to the exchange rate regime, relatively suddenly. Here are my thoughts on this, which I elaborate in more detail on www.businessmonitor.com :

• The announcement is a political manoeuvre, most probably designed to soothe US anger over the yuan’s stasis over the past two years, and placate the world’s major economies ahead of the G-20 meeting in Toronto this coming weekend.
• There is no guarantee that the yuan will actually appreciate by any significant magnitude. The PBoC’s statement says in its final paragraph that the exchange rate will be kept ‘basically stable’ to achieve ‘macroeconomic and financial stability’. Although the PBoC’s language on the global and Chinese economies was upbeat, my colleagues and I believe that China’s recent economic performance is unsustainable, and will see a slowdown in the second half of 2010 and 2011. In fact, BMI does not rule out a recession in China. A stronger yuan would probably hasten this process.
• As such, my colleagues and I point out that ‘flexibility’ is not a one-way bet. Indeed, if the PBoC had issued the same statement in December 2009, we would have expected a modest depreciation (say 2-3%) over the past six months. I do not expect this now, but the point is that the yuan is not a one-way currency, as is almost universally believed.
• Given the shaky state of the global economy, and the increasing likelihood of a second half slowdown, the PBoC is unlikely to let the yuan appreciate significantly.
• The trade-weighted yuan is already back to where it was in late 2008, when exports were falling sharply. With inflation rising and wage pressures mounting, the real effective exchange rate is also strengthening to a dangerously high level.
• Capital inflows could indeed accelerate after the PBoC’s announcement, but these could be offset by China’s negative real interest rates.

• In the long term, it certainly makes sense to expect the yuan to appreciate, especially as China seeks to rebalance its economy away from exports in favour of greater private consumption. However, this is a multi-year (and possibly multi-decade) phenomenon, and those expecting major yuan gains this year or even next are likely to be disappointed.

Tags: China, currency, exchange rate, Peg, reform, Renminbi, Revaluation, yuan
Posted in: Asia, China, Currencies, Financials, General
RSSFree email updates