Appreciation of Yuan slowing pace

21-July- As China marks the third anniversary of its currency reform, Beijing is preparing to slow the pace of yuan appreciation following complaints from exporters who are struggling to hold down costs in the face of a global economic downturn, analysts, government advisors and sources said.

The slowdown, which will follow the record pace of appreciation seen in the first half of this year, will mark the latest shift in an exchange rate reform strategy which has been under fire for several years for being either too cautious or too aggressive.

The yuan, which was estimated to be undervalued by 15-40 pct prior to revaluation, has risen by around 21 pct against the US dollar since it was depegged and moved to a managed float three years ago today.

The People’s Bank of China (PBOC) pushed for yuan reform in the months prior to July 2005 because the pegged system did not allow for any control over Chinese monetary policy, while expectations of a move were luring billions of dollars in speculative “hot money” into the country.

But three years later, China is struggling against its most serious inflationary bout in over a decade, the PBOC still does not have any monetary policy independence, and speculative inflows of hot money are estimated to be larger by several multiples.

The pace of appreciation in the three years of a managed float has reflected changes in China’s politics and its economy, both of which have played their roles in deciding how quickly the currency rises against the US dollar and the other majors.

Politics and economics will be brought to bear again on the pace of appreciation, analysts and government advisors said, with Beijing set to deliberately slow its rise in the final months of this year to help struggling exporters.

“The pace of appreciation will see periods of speeding up and slowing down, but the general trend is for it to slow,” said Zhu Baoliang, an economist and government advisor with the State Information Center, a think tank affiliated with the National Development and Reform Commission.

Zhu was a member of the one of the two teams that the government formed in early 2005 to assess the appropriate magnitude of the mid-summer revaluation.

The yuan has risen by nearly 7 pct against the dollar this year, already outstripping the 6.9 pct increase seen over the whole of 2007. Zhu predicted that the yuan could rise by around 10 pct over this year, implying another 3.5 pct rise for the remainder of this year.

The faster pace of appreciation seen in the first half was adopted in early December following the government’s shift to a “tight” monetary policy, and critics of the cautious nature of Chinese currency policy — including the US Treasury — were quick to notice and publicly encourage this shift.

The currency had risen by 11.8 pct prior to the December shift, and both Washington and Brussels — alongside a handful of voices in Beijing — were warning that the undervalued yuan was fueling unsustainable global imbalances and protectionism (the yuan has actually depreciated gains against the euro since July 2005 owing to dollar depreciation).

But the increase in the annualized pace of appreciation to as much as 17 pct in the first quarter this year has created its own problems, not least the threat posed by hot money. This has intensified a long-running debate among the tier of economists who advise the government on macroeconomic policy.

The apparent deterioration in monetary conditions has led to the near-daily calls from economists for a change in tack.

Some believe that only a virtual repegging of the currency — a sharp appreciation all at once or over a short period — would end the bets on appreciation, stemming the flow of dollars onshore and easing the PBOC’s sterilization burden.

“Since the July 21 revaluation, there has been this one strand of opinion calling for the yuan to rise faster to ease appreciation pressure, but the reality has been that the faster the yuan has risen, the bigger the appreciation expectations are,” said Zhao Qingming, an economist with the China Construction Bank in Beijing and a former PBOC researcher.

Opposition to the yuan’s speedy gains have a powerful ally in the shape of the Ministry of Commerce.

Data from the first half show the trade surplus falling by nearly 12 pct compared to the same period a year ago, with textile, shoe and clothing manufacturers particularly hard-hit. This has led to the yuan becoming the whipping horse of the export sector, which claims that currency appreciation is imposing an unbearable cost on operating conditions.

Others argue that a repegging would do nothing to end speculation and deprive China of a much-needed price setting tool and raise temperatures anew in the US and Europe.

They insist that the tide of hot money inflows — which have been estimated by Stone & McCarthy Research Associates at 160-180 bln usd in the first half alone, double the inflows for all of 2007 — require that aggressive action be taken to regain control of monetary policy.

Michael Pettis, a professor at Beijing University and observer of financial crises in Latin America in the 1980s and 1990s, insists that the monetary pressures caused by the government’s timidity will eventually force a significant one-off revaluation.

“Monetary policy since July 2005 and even before that can be basically described as “too little, too late” — the real problem is that there is no monetary policy in China, there is only a currency regime,” he said.

Although headline inflation appears to be easing with an increase in agricultural production, economists warn that the official data fail to provide an accurate picture of prices, and that the billions of dollars in inflows are fueling classic monetary inflation.

Unprecedented measures by the PBOC to control the flow of liquidity into the economy haven’t stopped M2 from growing by nearly 20 pct this year, even off last year’s impressive base.

Despite the Commerce Ministry’s opposition, some officials, who spoke on condition that their names not be published, said that the PBOC has a more powerful voice within the State Council than it has been given credit for. They also said that the debate over the yuan has little bearing on a leadership whose expertise in monetary affairs remains limited.

“This debate among economists isn’t having too much impact on policy,” said a source close to the cabinet.

One official argued that any significant overhaul of yuan reform policy would require the direct intervention of a leadership which, for now, is happy to leave the complexities of exchange rate issues at the ministry level.

“The Ministry of Commerce has been calling for a slower yuan rise since the start of this year but the pace of appreciation has actually sped up — this is proof enough that the PBOC is the most important force in deciding the yuan exchange rate’s movement,” said an official within the State Administration of Foreign Exchange.

That isn’t to say that the government is ignoring the implications of exchange rate policy choices.

The threat to the economic system posed by hot money has raised concerns at the highest levels of government and has prompted a tightening up of controls over the capital and trade accounts in recent weeks on the conviction that the trade surplus and foreign direct investment are acting as channels for bringing illicit funds onshore.

A one-off revaluation looks unlikely for a government which makes decisions by consensus and has demonstrated little willingness to take big, risky policy steps to complement China’s growing interdependence with the global economy.

Analysts insist that, even if a large one-off revaluation is the cure for China’s monetary ills, the unknown knock-on effects of such a move could have devastating consequences for an economy whose banking and industrial sectors remain stuck in transition between central planning and the market.

“Gradual and stable yuan appreciation remains the more realistic choice,” said Yang Yuanjie, a researcher within the Ministry of Finance said.

Source:XINHUA

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