Friday, April 11, 2008

Yuan continues rise against the dollar

This aritcle on the Yuan's steady appreciation against the US dollar appeared in yesterday's IHT. Domestic inflation in China is rising steadily, while the it's central bank is being pressured to allow further appreciation. The rising Yuan's effect on the US dollar coulpled with the ECB's recent decision to freeze interest rates portends further weakness for the US dollar.

Dollar falls below 7 yuan for first time since 1993

By Lu JianxinReuters
Thursday, April 10, 2008

SHANGHAI: The dollar weakened and slipped below 7.00 yuan on Thursday for the first time in over a decade, underlining China's growing economic strength and its increasing use of the currency as a policy tool.

The central bank, which tightly controls the foreign exchange market, paved the way for the rise by fixing the yuan's daily mid-point, or reference rate, at a fresh high of 6.9920 before trade began. The yuan opened at 6.9920 against the dollar compared to 7.0017 at Wednesday's close. It was the first trade above 7.00 since China devalued the yuan to 8.7 from 5.8 at the start of 1994, creating a modern foreign exchange market.

"China is now under both international and domestic pressure for the yuan to appreciate at a fast pace," said Liu Dongliang, currency analyst at China Merchants Bank in Shenzhen. The Chinese central bank tightly controls the market through regulations and indirect intervention, and has limited the pace of yuan appreciation to support growth in China's exports.

But since July 2005, when the yuan was revalued and its peg to the dollar scrapped, its rise against the dollar has gained pace each year, from 2.6 percent in 2005 to 3.4 percent in 2006 and 6.9 percent in 2007. So far this year, it is up 4.5 percent. The acceleration is partly due to the weakness of the dollar in global markets, and to diplomatic pressure by China's major trading partners for faster appreciation to cut the huge Chinese trade surplus.

Last November, the central bank declared for the first time that it would use the exchange rate actively to fight inflation, which hit an 11-year high of 8.7 percent in February this year. That suggests China is gradually shifting toward managing its currency in the same way as developed economies, allowing big swings to cool the economy when it overheats and to stimulate it during slowdowns, analysts said.

"There now appears to be a clear understanding among the top leadership that sticking to a devalued currency is not good for the Chinese economy, including inflation," said a dealer at a top Chinese state-owned bank in Beijing. He declined to be named because he was not authorized to speak publicly to media.

Yuan appreciation has become especially important to restrain inflation since the start of this year as the central bank has partially loosened domestic monetary policy, flooding the money market with funds to ease financing problems at small companies.

Some foreign investment banks speculate that to prevent inflows into China of funds betting on continuous yuan appreciation, authorities may resort to another large, immediate revaluation of the currency.
But Chinese leaders have publicly ruled out such a step, and the onshore foreign exchange market believes it is highly unlikely because of the instability it could cause.

Instead, dealers said yuan appreciation will slow in the second half of this year as inflation eases and the central bank guards the economy against a slowdown in U.S. and global growth. While the strong yuan helps Chinese firms such as airlines and oil importers to reduce their overseas procurement costs, it is already hurting lower-end exporters such as clothing makers.

Reflecting expectations for yuan appreciation to slow later in 2008, one-year appreciation against the dollar implied by offshore forwards has dropped in recent weeks, to 11.2 percent on Thursday from a record 13.8 percent in mid-March.

Onshore dealers generally have predicted the yuan will appreciate 8.5 to 10 percent for all of this year. The yuan's strength is gradually making it an attractive store of value around the region. Yuan bank accounts in Hong Kong are expanding rapidly, and Chinese businessmen and tourists informally exchange the yuan around southeast Asia.

But for the yuan to become a major traded currency on the scale of the dollar or euro, China will need to remove capital controls and allow much greater market volatility- steps which remain many years away, analysts said.

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