China Takes Half-Step on Yuan

Widened band may not speed appreciation of currency.
An analysis by Michael Lelyveld
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A Chinese clerk counts yuan bills at a bank in Nantong city, east China's Jiangsu province, Feb. 24, 2012.
A Chinese clerk counts yuan bills at a bank in Nantong city, east China's Jiangsu province, Feb. 24, 2012.

China's latest move toward currency reform may have less consequence than many reports suggest, experts say.

On April 16, the People's Bank of China (PBOC) increased the trading band of the yuan against the dollar from 0.5 to 1 percent, marking the first widening of the fixed currency's corridor since 2007.

The official English-language China Daily hailed the announcement as "a breakthrough in the process of forming [China's] market based currency exchange rate."

In one report, Reuters called the move "a milestone step in turning the yuan into a global currency."

The Communist Party's paper People's Daily called the change "a giant step."

But experts say the measure is unlikely to be a turning point in long-running frictions with the United States over the yuan's relatively low value and its pace of appreciation against the dollar.

"I tend to see it as something less," said Harvard University economist Dale Jorgenson. "In terms of the competitiveness of the Chinese economy versus the U.S., I don't think this is a big event."

Export edge

Many U.S. economists, manufacturers and labor groups have argued since 2003 that China has deliberately undervalued the yuan by 25 to 40 percent to give its exports an edge, contributing to the record $295-billion bilateral U.S. trade deficit last year.

China allowed the yuan to rise gradually under a 2005 currency reform, but it virtually froze the process from 2008 to 2010, citing concerns about the global economic slump. All told, the yuan has appreciated in nominal terms by about 24 percent.

But for more than a year, the larger change has come about from China's faster inflation, which has pushed appreciation of the real effective exchange rate to a 31-percent rise since the 2005 reform.

"The big event is in the gradual appreciation of the real exchange rate of the yuan against the dollar," Jorgenson told RFA.

In the first quarter of this year, China's consumer price index (CPI) climbed 3.8 percent compared with a 2.7-percent rise in the United States, although nominal appreciation has barely budged.

China's government is motivated to give citizens more buying power to shift the basis of the economy toward consumption and help cope with inflation, arguing in favor of a stronger currency. But at the same time, inflation may affect appreciation in nominal terms, despite the widened band.

"The direction is definitely going to be appreciation ...[but] not necessarily a more rapid pace," said Jorgenson. "It depends on the relative inflation rate."

Jorgenson said the idea is to let the exchange rate be determined more by market forces with less intervention, but as The New York Times noted, the PBOC will continue to set the daily benchmark rate, which "has shown virtually no change this year."


The U.S. Treasury Department gave a mixed review to the measure in a statement attributed to an unnamed official.

China's decision, "if implemented in a way that allows the value of the exchange rate to reflect market forces, could contribute to rebalancing, which would be positive for China, the United States, and the global economy," said the official.

"While we welcome the progress to date, the process of correcting the misalignment of China's exchange rate remains incomplete, and further progress is needed," the statement said.

In an analysis, the official Xinhua news agency said the bigger band would make it harder for speculators to place one-way bets on appreciation, due to the higher risk of being wrong.

Speculative inflows of "hot money" have been a problem for inflation, but a slowdown could also ease pressure for a faster rise of the yuan.

In recent comments, Premier Wen Jiabao has also suggested that the yuan is "approaching equilibrium," signaling a slower pace of change.

In its "Heard on the Street" column, The Wall Street Journal called the new currency policy "another nail in the coffin of hopes for rapid yuan appreciation."

Rising U.S. deficit

Chinese officials point to a shrinking global trade surplus this year, although the U.S. bilateral trade deficit through February has risen 7.7 percent from a year earlier, according to Census Bureau data.

The uncertainty of the move's effect on the exchange rate was demonstrated on the first day of trading as the yuan weakened before strengthening by a smaller amount the next day.

For the week, the currency fell against the dollar by 0.09 percent, Bloomberg News said.

Longtime critics of China's trade policies voiced skepticism that the widening of the currency band will prove to be a breakthrough.

"Certainly, there's a heavy burden of proof on the optimists," said Alan Tonelson, research fellow at the U.S. Business and Industry Council Educational Foundation, a Washington-based group sponsored by American manufacturers.

Tonelson noted that fluctuation of the yuan has rarely reached the limits of even its narrower trading band, suggesting that the widening will make little difference.

"It seems that the actual bounds of the band are not influencing trading much at all, and I certainly expect that trend to continue," Tonelson said in an interview.

Daily rate

Slightly looser reins on the yuan are still a far cry from a free-floating currency as long as the PBOC continues to set the daily benchmark or reference rate.

"There are no signs that the Chinese government is about to switch to a policy that enables markets to control the yuan's value rather than government dictates," Tonelson said.

Tonelson is also not convinced that the PBOC is committed to further appreciation.

"I would not be surprised to see the yuan weakening further as times goes on," he said.

Even if the currency strengthens, it will not necessarily keep China from shifting its focus to other unfair trade advantages such as subsidies and tax breaks for exports, Tonelson argued.

"History should be teaching us that these predatory trade practices are fully fungible," he said.





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