On June 19, the
People's Bank of China (PBOC) vowed to increase the Chinese CNY's flexibility
and abandoned a 23-month-old peg to the USD. Chinese authorities had prevented
the currency from strengthening, with the CNY essentially pegged to the USD
since July 2008 to help exporters cope with sliding demand triggered by the
global financial crisis. The PBOC said China will move into a managed floating
exchange rate regime based on market supply and demand of a basket of
currencies.
Such announcement came just a week before the June 26–27 G-20
summit and was successful in defusing the trade tension between the U.S. and
China. Countries in general welcomed the move by China. Just one day earlier,
tension appeared to be running high when Beijing said its currency had no place
on the agenda at the meeting, after U.S. President Obama released a letter to
his G-20 colleagues saying that free-floating currencies were "essential" for
global economic stability.
The PBOC said the decision to increase the
CNY's flexibility was made after the domestic economy has improved. Central bank
governor Zhou had long indicated that China would eventually move away from its
recent exchange rate policies, which he described as a temporary response to the
global financial crisis. This comes as China has achieved a significant
turnaround in economic growth, with annual GDP accelerating to +11.9 percent in
Q1, the highest since Q4 2007. Given the substantial momentum into Q2, the
mainstream forecast is for 10.5 percent annual growth this year. This robust
growth expectation presumably allows Beijing to tolerate any drag from moderate
currency appreciation.
On another dimension, CNY appreciation has been
viewed as a means to help contain inflationary pressure. The Chinese CPI climbed
to a 19-month high of 3.1 percent year-to-year in May, surpassing the official
target of 3 percent inflation in 2010. In media interviews during recent months,
some Chinese executives have joined in backing a stronger CNY, recognizing the
benefits of lowering the price of imported inputs.
By letting loose the
CNY before the G-20 Summit, China dodged a political bullet for now. But going
forward, there is still potential for trade tensions between the U.S. and China
if CNY appreciation is deemed insufficient.
One-time Big Gain
Unlikely
It remains unclear how much the currency will China allow to
strengthen. The PBOC appeared to rule out a one-time revaluation, saying there
is no basis for "large-scale appreciation." Yesterday, PBOC's vice governor
Xiaolian said that it is beneficial for major currencies, including China's, to
have some flexibility, but big swings in value would be harmful to the economy.
She noted that China's current account surplus had been shrinking as a share of
GDP and said such movements were indications of the underlying fundamentals of a
currency's value, hinting that pressure for it to appreciate might be
easing.
Since the June 19 announcement, the PBOC has been true to its
word in allowing more flexibility. The central bank has let the CNY fluctuate
more broadly than before within its daily band against the USD of 0.5 percent on
either side of the midpoint established every morning. In the past, the CNY
rarely fluctuated more than 0.1 percent during intraday trading. However, given
the lingering concerns about the global economy, Beijing will be unwilling to
push the CNY value up too rapidly.
Gradual Appreciation Most
Likely
Rather, the PBOC is likely to revert to a gradual appreciation
against the USD, similar to that which prevailed for three years through
mid-2008. The China Center for International Economic Exchanges, a
well-connected think tank, said last Wednesday that China will suffer an
economic slowdown in Q3 as export and investment growth weakens and year-on-year
growth could slow to only around 9 percent in Q3. China needs to maintain growth
of around 10 percent for the next five years to create enough jobs and ensure
social stability. The think tank also said that Chinese exporters could cope
with a gradual rise of 3 percent this year under such a scenario. Any increase
exceeding that will be difficult.
China's export outlook is a concern to
China, especially because of the slowdown from the unresolved sovereign debt
problem in Europe, China's biggest trade partner. Efforts to crack new markets
in emerging countries would not make up for exports lost in Europe. Some
economists expect China to actually record a trade deficit during the second
half of 2010, which could shrink the full-year trade surplus to as little as $50
billion from $196.1 billion last year.
Concerns about the global economy
are real enough to prevent China from allowing a sharp rise in CNY as that might
prove too risky. On the other hand, CNY appreciation has been a source of
friction between the U.S. and China. There is strong pressure from Congress to
impose tariffs on Chinese exports due to the CNY undervaluation. De-pegging CNY
from the USD and the willingness to allow more CNY flexibility is a good first
step by PBOC to diffuse the pressure. More than two weeks into the de-pegging,
the PBOC has so far indicated that it is trying to keep the CNY's value stable
against a basket of currencies as announced by balancing the gains and losses of
CNY against the USD and non-USD currencies.
China has to continue
striking a delicate balance between its domestic needs and the external demands.
The current forecast of 33 economists polled by Reuters was for CNY to end 2010
at 6.67 per USD, an annual rise of 2.4 percent. The offshore non-deliverable
forwards market is pricing in an even more modest rise of 1.2 percent to 6.7450.
It remains to be seen if the actual magnitude of CNY appreciation in the coming
months will satisfy the U.S. Congress, especially when the November election is
approaching. In this context, it might take some time to determine a clear
appreciation trend of the CNY.
The views expressed in this column are solely those of the author and do not
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