To free mar­ket, with the yuan

Yuan ap­pre­ci­a­tion this time is sin­gu­larly free of the usual high- deci­bel para­noia of ‘ hot money’ flow­ing into China

The Pak Banker - - Front Page -

BEI­JING

Some­thing unique is hap­pen­ing in China. Mar­ket forces are be­ing al­lowed to pre­vail in the func­tion­ing of the yuan and there is a dis­tinct like­li­hood that the Chi­nese cur­rency may be­come more free and flex­i­ble in the near fu­ture.

The ex­change rate of the yuan, or ren­minbi as it is known, hit a record high on Oc­to­ber 26, go­ing up to 6.24 yuan against the US dol­lar - its strong­est level in 19 years. This came close on the heels of a bullish cur­rency trend in Septem­ber – a month which saw the largest jump in cap­i­tal in­flows since the be­gin­ning of the year. China ex­perts are op­ti­mistic that the yuan could climb to 6.19 per dol­lar by the end of 2013.

Yuan ap­pre­ci­a­tion this time is sin­gu­larly free of the usual high-deci­bel para­noia of ‘hot money’ flow­ing into China. The re­cent hike in the yuan against the dol­lar was mainly be­cause the Peo­ple’s Bank of China (PBOC) didn’t sell the yuan and pur­chase for­eign cur­rency, as is the prac­tice. Pre­vi­ously, with a large bal­ance of pay­ments sur­plus, China’s cen­tral bank had to in­ter­vene mas­sively to pre­vent mar­ket pres­sures from driv­ing the yuan up sharply. This sur­plus has come down re­cently, as China has in­creased its im­ports. There­fore, at the mo­ment, it can al­low the cur­rency to be de­ter­mined largely by mar­ket forces with­out set­ting off a sharp ap­pre­ci­a­tion that may badly hurt ex­ports.

This al­tered set of cir­cum­stances could well be a pre­cur­sor to the next step in fi­nan­cial and mone­tary re­form as ul­tra­con­ser­va­tive pol­i­cy­mak­ers sig­nal that the coun­try’s econ­omy and fi­nan­cial sys­tem are ro­bust enough to with­stand fur­ther flex­i­bil­ity in the ex­change rate.

Money mar­ket ex­perts strongly feel that it is time for PBOC to re­duce in­ter­ven­tion in the cur­rency mar­kets and let the yuan float freely. Cir­cum­stances have changed rad­i­cally. It is eas­ier for pol­i­cy­mak­ers now to al­low mar­ket pres­sures to op­er­ate in the for­eign ex­change mar­ket than it was dur­ing a heav­ily ex­port-driven econ­omy.

So why is the ren­minbi ap­pre­ciat- ing, and why is China not get­ting up­set about the trend? A care­ful mone­tary pol­icy, a sta­bilised Chi­nese econ­omy and third round of quan­ti­ta­tive eas­ing in the United States has led to the strength­en­ing of the yuan and is likely to continue in the short-term.

China’s econ­omy, ac­cord­ing to the Na­tional Bureau of Sta­tis­tics, ex­panded by 7.7 per­cent year on year in the first three quar­ters, higher than the 7.5 per­cent an­nual eco­nomic growth tar­get set for 2012. Signs of eco­nomic sta­bi­liza­tion are now ap­par­ent to the world, en­cour­ag­ing over­seas cap­i­tal to en­ter China.

Across the seas, the US Fed­eral Re­serve ex­tended the du­ra­tion of its ul­tralow in­ter­est rates to bol­ster its own weak eco­nomic re­cov­ery. Dif­fer­ences in in­vest­ment re­turns, in­ter­est rates and ex­change rates are now the de­ter­min­ing fac­tors for in­ter­na­tional cap­i­tal to en­ter China.

Yuan hold­ings among banks for pur­chas­ing for­eign ex­change, a key mea­sure of cap­i­tal flows, rose 130.7 bil­lion to 25.8 tril­lion yuan in Septem­ber. As ma­jor economies sta­bi­lize and cap­i­tal con­tin­ues to flow into emerg­ing coun­tries, yuan hold­ings for pur­chas­ing for­eign ex­change would continue to grow in the next few months. The buzz that the re­cent yuan strength has mainly been driven by mar­ket forces like cap­i­tal flows, as op­posed to tweak­ing by the cen­tral bank has gen­er­ated a lot of op­ti­mism.

In the last two months of this year, the gov­ern­ment may send a strong sig­nal that the yuan will be fur­ther lib­er­al­ized and will be more mar­ket driven. The PBOC may al­low more flex­i­bil­ity and broaden the per­mit­ted fluc­tu­a­tion lim­its of the cur­rency. Since April, the cen­tral bank had al­lowed the yuan to fluc­tu­ate by 1 per­cent from the ar­ti­fi­cially set daily mid-point and economists now ex­pect that fluc­tu­a­tion lim­its can be ex­tended from the cur­rent 1 per­cent to 2.5 per­cent af­ter two mega po­lit­i­cal events – the US pres­i­den­tial elec­tions and the 18th Na­tional Congress of the Com­mu­nist Party of China – get over. With this in­her­ent strength, the yuan has al­ready be­gun to es­tab­lish it­self as the Asia Pa­cific’s re­gional ref­er­ence cur­rency.

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