New Chinese currency policy lifts markets

By JAGDEV SINGH SIDHU
jagdev@thestar.com.my

Equities, currencies and commodities react positively to unpegging proposal

KUALA LUMPUR: Stock markets, currencies and commodities were given a boost after China signalled the end of its yuan peg to the US dollar.

Markets in Asia posted strong gains led by China, Hong Kong and Japan as investors took positions that a stronger yuan would lead to stronger consumption and demand within China and help drive exports of its major trading partners.

People’s Bank of China over the weekend said it was abandoning its peg to the US dollar, a move taken to shelter the China economy during the recent global crisis, and was reinstituting a managed float it first detailed in July 2005.

The bank said that while there was no large movement in the yuan, the exchange rate would be allowed increased flexibility.

“The yuan flexibility is bullish for a number of Asian currencies,” said CIMB Invesment Bank’s regional rates/FX strategist Suresh Kumar Ramanathan, who expects the ringgit to gradually appreciate against the dollar to RM3.05 by the end of the year.

The yuan moved to 6.79 against the dollar from 6.83 following the revaluation of the currency, its highest level in 18 months.

It was revalued to 8.11 to the dollar in July 2005 and gradually appreciated to 6.81 before it was pegged at around that level to protect its exporters and the economy during the crisis in 2008.

That statement was the catalyst for a spike in Asian stock markets and currencies, all of which posted healthy gains on the back of the stronger yuan.

“We expect equity markets to take the news positively in the short term, boding well for regional risk appetite,” Nomura said in a note yesterday. “However, the implied forward rates of appreciation will likely continue to be overshadowed by global growth concerns and ongoing jitters over European credit markets.”

The ringgit strengthened to RM3.18 to the dollar with the FTSE Bursa Malaysia Kuala Lumpur Composite Index (FBM KLCI) closing up 1.34% to 1335.29.

The ringgit’s jump, sparked by the move in the yuan, was also beefed up by short-covering and stop-loss calls by traders who were long on the dollar.

The breaching of the RM3.24 level against the greenback was attributed to the buying of the ringgit.

Economists felt that the benefit to Malaysia’s economy would depend on just how the yuan moves from here on and an appreciation over time would, nonetheless, be positive for the economy and Malaysian exporters.

Affin Investment Bank chief economist Alan Tan said a stronger Chinese currency would boost consumption and domestic demand but there were risks associated with that if the currency appreciated too fast.

“They cannot risk a strong currency as it could hurt exports. They remain dependent on exports,” he said.
The FBM KLCI extended its winning run to 10 straight trading days with investors buying a plethora of stocks from small-caps to heavyweight stocks in active trade.

Dividend yielding blue chips, such as DiGi.com Bhd and Public Bank Bhd, attracted buying interest along with automakers as investors reacted to the yuan revaluation.

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Editor's note: The decision by the People's Bank of China, the central bank, to "further strengthen the formation mechanism of the yuan's exchange rate and increase the flexibility of the currency" on Saturday has aroused worldwide attention for its far-reaching effect on both the Chinese and global economy. The next day, the central bank released another statement claiming that there would not be a one-off revaluation of the yuan, which is well in line with Chinese economists' expectations, who said outside pressure would not disappear following the latest move.

In the short term, it is more important for the monetary authorities to let the yuan float in a broader band rather than pegging it to a basket of currencies.

Given the recent exchange rate movement of the world's major currencies, if China strictly follows the rule of pegging the yuan to a basket of currencies, it may depreciate substantially against the US dollar. But the central bank will not allow that to happen, especially when the exchange rate issue has become highly sensitive.

The yuan could appreciate 3-5 percent against the US dollar this year. The Chinese authorities will not accept a big increase in the yuan's exchange rate against the dollar, because the yuan's effective exchange rate has risen substantially against the greenback this year and the trade surplus is shrinking.

The new announcement of the yuan's exchange rate regime, which has been interpreted as the start of yuan appreciation, does not mean that outside pressure for yuan appreciation will disappear. The pace and margin of the renminbi's rise against the US dollar will become the main theme for the next round of discussion on the yuan's exchange rate.

Once the yuan resumes appreciation, the authorities must keep a close eye on cross-border capital controls and prevent resurgent excess liquidity as a result of rising asset prices.

China remains in the stage of initial industrialization while the US has entered a post-industrial era.

The root of the huge US trade deficit with China lies in the differences in their economic structures and development levels.

The yuan's exchange rate is neither the main contributor to the bilateral trade imbalance, nor a panacea for solving the issue.

A sharp one-off revaluation of the yuan's exchange rate will significantly increase the cost of living of ordinary Americans, especially low- and middle-income groups, because it would push up the cost of Chinese exports to the US market, thus curbing US domestic consumption, which is important for its economic recovery.

Yuan appreciation will result in a decline in the growth of China's exports, from which migrant workers, China's most vulnerable group, will suffer the most.

Sluggish exports in turn will impact China's long-term efforts to expand domestic demand and transform the economic development pattern.

So far, China is the most powerful driving force for global economic growth.

A slowdown in China would deal a blow to economic confidence worldwide and affect the smooth recovery of the global economy.

The decision of the People's Bank of China, the central bank, to proceed with the reform of the yuan's exchange rate regime is of great significance, because it symbolizes the end of China's temporary yuan peg policy to mitigate the impact of the global financial crisis over the past 23 months. Such a move also indicates China will adopt an independent exchange rate regime without yielding to external pressure.

The move aims to relieve inflationary pressure and promote the structural adjustment of China's export-oriented enterprises.

The yuan's exchange rate will become more flexible and is likely to experience two-way fluctuations in the future, which means the exchange rate of the yuan may either appreciate or depreciate against major currencies. If the euro continues to remain weak against the US dollar or the value of the US dollar rises by a large margin against other major currencies, the yuan could depreciate against the dollar.

Therefore, the central bank's latest move cannot be simply interpreted as the start of yuan appreciation against the dollar. Even if the yuan appreciates in the future, according to historical experience, the central bank will keep the currency basically stable at a reasonable and balanced level and allow the yuan to appreciate in a gradual, moderate and controllable way instead of a sharp one-off revaluation.

The recent adjustment in China's currency policy is a move in the right direction, marking a key step in the reform of China's exchange rate regime towards a more market-based one.

If the yuan rises against other currencies after the latest policy initiative, it should rise gradually, otherwise it could be a heavy blow to the country's export-oriented enterprises.

Mild yuan appreciation will spur export companies to continue to improve their technology and management, but a hasty and big increase in the yuan's exchange rate would be the death knell for these companies. The 11 percent appreciation in the yuan between October 2007 and July 2008 led to the bankruptcies of some 67,000 export companies and mass job losses.

It is expected that the yuan will only go up within a limited range. European economies face the risk of a double-dip and have decided to cut spending to fight the debt crisis, which will definitely affect consumption in those countries and thus pose a threat to China's exports to Europe. If the yuan rises against the dollar this year, the margin would only be very slight. China will allow its currency to appreciate by up to 3 percent only if the country could make sure its exports rise by an average of 20 percent in 2011 and the global economy regains its sound growth momentum.

The central bank's decision helps contain "imported" inflationary pressures and therefore reduces the probability of aggressive monetary tightening through stringent credit controls and/or consecutive interest rate hikes.

This policy move should help contain inflationary pressures in the short term and rebalance the Chinese economy over the medium and long term.

A modest initial revaluation followed by gradual appreciation would fuel expectations of further yuan appreciation over time.

Unpegging the renminbi and a subsequent gradual appreciation against the US dollar should be positive for the stock market, even though a stronger renminbi will likely hurt low margin exporters who do not have pricing power.

Although the central parity of the yuan-dollar exchange rate is, in principle, determined based on the weighted average of the quotes from market makers, it is still heavily managed by the People's Bank of China, which has considerable discretion over determining the weights when the weighted average is calculated.

Thus, the pace of renminbi appreciation ultimately hinges on how comfortable the Chinese authorities are with allowing faster appreciation of the central parity rate instead of intra-day volatility around the central parity rate.

Source: China Daily
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RMB reform restarts, to aid China and world

Analyzing Beijing's announcement over the weekend it will restart the reform of the RMB exchange rate regime, China observers say the move is "wise" which will accelerate the country to climb another step on the industrial ladder.

More than a dozen economists and international investment bankers welcomed Beijing's decision to un-peg the RMB with the U.S. dollar from today, but, they cautioned that China's regulators would try to prevent any big volatility in the exchange rate, which does not help China's and the global economy, and is likely to rein in the scope of the yearly rise of the RMB value against the U.S. dollar within 3-4 percent.

Economists believe an annual 3-4 percent rise of the RMB will be capable of stonewalling speculative "hot money" entering China, which will jeopardize the economy and increase the risks of inflation in the country.

Since the People's Bank of China (PBOC), the central bank, initiated the RMB rate reform in July 2005, China's currency has gained 21 percent against the U.S. dollar. But Beijing pegged the RMB to the greenback in late 2008 when the global financial crisis erupted.

Now fairly ensured the global economic recovery is on a solid footing and its exports had rebounded since April, Beijing finally decided to enhance the RMB exchange rate flexibility, to help squeeze out low-value labor-intensive production, and to sooth rising outside cries that the RMB must be revalued.

U.S. President Barack Obama said China's move is a "constructive step" while the International Monetary Fund director-general Dominique Strauss-Kahn described the move as a "very welcome development".

"China's decision to increase the flexibility of its exchange rate is a constructive step that can help safeguard the recovery and contribute to a more balanced global economy," Obama said in a statement.

The European Union said that "such a move will be beneficial for both the Chinese economy and the global economy," adding that the move would not only benefit China's own economy but also the economy of the world as a whole. EU even hailed the move as "providing an important contribution to the success" of the G20 Toronto summit, which are scheduled for late this week.

Beijing's decision was made in view of the economic situation and financial market developments at home and abroad, and the balance of payments situation in China, the PBOC spokesperson said in a statement.

The reform of the RMB exchange rate regime is to reflect market supply and demand "with reference to a basket of currencies", that including the U.S. dollar, the euro, the yen, the British pound, and other currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market, PBOC said.

The statement emphasized the RMB be pegged to a basket of currencies, adding that the US dollar should not be the only gauge for judging the RMB exchange rate level.

The central bank said on Sunday it will not conduct a one-off revaluation of the RMB exchange rate this time, as promised by Premier Wen Jiabao. On July 21, 2005, when China started the reform, it allowed a one-off RMB rise of 2 percent against the U.S. dollar.

U.S. Treasury Secretary Timothy Geithner also welcomed China's decision to further reform its exchange rate mechanism and expected further cooperation with his Chinese counterpart within G-20 to promote the economic recovery.

By People's Daily Online

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