China Signals End to Yuan’s Two-Year Peg to Dollar

June 19 (Bloomberg) -- China said it will allow a more flexible yuan, signaling an end to the currency’s two-year-old peg to the dollar a week before a Group of 20 summit.

The decision to “increase the renminbi’s exchange-rate flexibility” was made after the economy improved, the central bank said in a statement on its website, without indicating a time-frame for the change. It ruled out a one-off revaluation, saying there is no basis for “large-scale appreciation,” and kept the yuan’s 0.5 percent daily trading band unchanged.

“The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability,” the People’s Bank of China said in the statement. “It is desirable to proceed further with reform of the renminbi exchange-rate regime and increase the renminbi exchange-rate flexibility.”

The decision may help deflect criticism of China when G-20 leaders meet on June 26-27 in Toronto and ease pressure from U.S. lawmakers, who have urged President Barack Obama to use the threat of trade sanctions to force policy change. A more flexible currency would give China more freedom to decide on monetary policy and reduce inflationary pressures by lowering import costs, the World Bank said in a report last week.

U.S. politicians “can declare this a partial victory,” said Ma Jun, a Hong Kong-based economist for Deutsche Bank AG. “The impact of this reform on the real economy over the short-term will be limited, because the yuan is unlikely to move significantly against the currency basket.”

Winners and Losers

Chinese authorities have prevented the currency from strengthening since July 2008 to help exporters cope with sliding demand triggered by the global financial crisis. The currency appreciated 21 percent in the three years after a peg to the dollar was scrapped in July 2005 and replaced by a managed float against a basket of currencies including the euro and the Japanese yen. The yuan is a denomination of China’s currency, the renminbi.

Companies focused on the Chinese market, including Beijing- based computer maker Lenovo Group Ltd. and Shanghai-based China Eastern Airlines Corp., said in March that they would gain from lower import costs and stronger consumer-purchasing power should the yuan appreciate. Textiles makers would stand to lose the most and some would “face bankruptcy” as their profit margins are as low as 3 percent, Zhang Wei, vice chairman of the China Council for the Promotion of International Trade, said in March.

China’s inflation rate jumped to a 19-month high of 3.1 percent in May, higher than the government’s full-year target of 3 percent. Central bank dollar buying has left the nation with $2.4 trillion in currency reserves, the world’s largest holding.

Crisis Policies

“China has ended its crisis-mode exchange-rate policy as the economy recovers strongly and inflationary pressure continues to build,” Li Daokui, an adviser on the People’s Bank of China’s policy board, said in an interview. “The yuan’s future trend depends on the euro’s movement, and the trends of other major currencies.”

Yuan 12-month forwards rose the most this year yesterday, gaining 0.5 percent to 6.7125 per dollar. The contracts reflect bets the currency will appreciate 1.7 percent from the spot rate of 6.8262. They had been pricing in appreciation of 3.2 percent on April 30 before a slump in the euro and a worsening of Europe’s debt crisis eased pressure for appreciation.

“The central bank’s statement means China’s exit from the dollar peg,” said Zhao Qingming, an analyst in Beijing at China Construction Bank, the nation’s second-biggest bank by market value. “If the euro continues to remain weak, it could also mean that the yuan may depreciate against the dollar.”

Treasury Response

U.S. Treasury Secretary Timothy F. Geithner praised China’s decision today to allow more currency flexibility and said the pledge needs to be followed by “vigorous” action to help strengthen the global economy.

“We welcome China’s decision to increase the flexibility of its exchange rate,” he said in a statement released today in Washington. “Vigorous implementation would make a positive contribution to strong and balanced global growth.”

Geithner on April 3 postponed an April 15 deadline for a semiannual review of the currency policies of major U.S. trading partners, which may have resulted in China being labeled a currency manipulator. China owned $895.2 billion of U.S. Treasuries as of the end of March, the largest holdings.

Today’s announcement is “a gesture to the U.S., but without a specific timetable,” said Tao Dong, a Hong Kong-based economist at Credit Suisse Group AG. “The pressure is on China now to move its exchange rate ahead of the G-20 summit.”

Currency Basket

China’s overseas sales jumped 48.5 percent in May from a year earlier, the biggest gain in more than six years, according to customs bureau data June 10. Exports exceeded imports by $19.5 billion, from $1.68 billion in April and a deficit of $7.24 billion in March that was the first in six years.

China’s narrowing balance of payments gap indicates that there’s no basis for “large-scale appreciation” by the yuan, the central bank said in the English version of its statement. The Chinese version said no “large-scale volatility”

Twelve of 19 respondents surveyed by Bloomberg in April predicted the central bank would allow the currency to float more freely this quarter, while the rest saw a move by year-end. Eleven ruled out a one-off revaluation, while fifteen predicted a wider daily trading range.

“Continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies,” the statement said. That suggests a looser link to the dollar, said Ben Simpfendorfer, chief China economist at Royal Bank of Scotland Group Plc, in Hong Kong.

“China has to offer something ahead of the G-20,” he said. “Greater flexibility allows them the option to appreciate against the dollar, perhaps during periods of dollar weakness.”

http://www.bloomberg.com/apps/news?pid=20601087&sid=aPTR0m8mvZXY&pos=1

 

about as clear as mud.

 

http://www.pbc.gov.cn/english/detail.asp?col=6400&id=1488

no time line is given.

 

Very predictable. They need to do so because their currency has appreciated in real terms vs the euro. The eurozone is their 2nd biggest market and has overpriced itself by the fall in the Euro.

 

So, from what I can see here, market will like it on Monday, and go up, and then will rethink that on Tuesday.
Sounds like a plan...