China Doubling Yuan Band Signals Drive for Convertibility

China’s decision to widen the yuan’s trading band against the dollar for the first time since 2007 signals a drive toward a convertible currency that also saw overseas investors get bigger investment quotas this month.

The band’s increase to 1 percent from 0.5 percent takes effect tomorrow, the People’s Bank of China said on its website yesterday. This month, regulators raised quotas for foreigners buying onshore stocks and bonds to $80 billion from $30 billion and increased the amount of yuan held offshore that can be invested locally.

Chinese officials pledged in a five-year plan running through 2015 to keep loosening controls on currency flows as Premier Wen Jiabao targets higher domestic consumption and an enlarged global role for the yuan that would curb the dollar’s dominance. Mizuho Securities Asia Ltd. said yesterday that moves including the increased investment quotas indicate that the government is stepping up the pace of its efforts.

“Greater two-way exchange rate risk makes possible capital account opening, which would be a logical next step,” said Tim Condon, chief Asia economist at ING Financial Markets in Singapore. “If so, we are in the early stage of what will be as momentous for China” as the nation joining the World Trade Organization in 2001, he said.

Trading Band

The previous broadening of the trading band, which is centered on a rate set daily by the central bank, was from 0.3 percent in May 2007. Gains in the currency against the dollar have stalled this year as China’s growth slows and officials say that the yuan may be near “equilibrium.”

“It’s a positive decision and one that the market has long waited for,” Helen Qiao, an economist at Morgan Stanley in Hong Kong, said yesterday. “But in the end, the most important thing to watch is how much of that band will actually be used.”

Still, the U.S. Treasury Department says China needs to do more. “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,” a Treasury official said in an e-mailed statement. “China’s decision to widen the daily trading band for its exchange rate, 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 U.S. and the global economy.”

At Standard Chartered Plc, Shanghai-based economist Li Wei said yesterday that more “two-way variability” in the yuan is a pre-condition for opening the capital account because of the reduced risk of one-way capital inflows.

‘High on Agenda’

“High on China’s financial reform agenda is to increase its capital account opening to allow domestically trapped idle money to invest offshore for better uses and returns,” Li added.

The yuan ended last week at 6.3030 per dollar, up about 8.3 percent since the scrapping in June 2010 of an almost two-year peg imposed during the global financial crisis.

In a March 5 state-of-the-nation address, Wen said that the government will “work steadily” to make the currency convertible under the capital account and expand the use of the yuan in cross-border trade and investment.

Yesterday’s announcement came days before the International Monetary Fund and Group of 20 hold talks in Washington, forums used by finance chiefs to lobby China to let the yuan gain.

“This underlines China’s commitment to rebalance its economy toward domestic consumption and allow market forces to play a greater role in determining the level of the exchange rate,” Christine Lagarde, managing director of the IMF, said in a statement.

‘Political Year’

Expectations for a stronger currency dwindled in the past six months as Wen cut the country’s economic growth target, Europe’s sovereign-debt crisis hurt exports, and China’s trade deficit in February swelled to the biggest since at least 1989.

Political pressure may be a “main factor” in the latest move, said Ren Xianfang, a Beijing-based economist with IHS Global Insight Ltd., who added that this is a “political year” because of a looming U.S. presidential election.

While the yuan reached an 18-year high at 6.2884 per dollar on Feb. 10, President Barack Obama’s administration and U.S. lawmakers say the currency remains weak enough to give China, the world’s biggest exporter, an unfair advantage in trade.

The Obama administration is reviewing China’s announcement “very closely,” Ben Rhodes, a deputy national security adviser at the White House, told reporters in Cartagena, Colombia, where Obama is attending summit of Latin American leaders. “They’ve made some progress and we’d like to see more.”

‘Little Gift’

China always tries “to offer something” before big international meetings, said David Smick, a former Congress staff member and chief executive officer at Washington-based consultancy Johnson Smick International Inc. “It’s like when you go to dinner you take a little gift,” Smick said in Berlin.

After keeping the exchange rate stable for a decade, China allowed its currency to strengthen 21 percent from July 2005 to July 2008, including an initial, single-day gain of 2 percent. Appreciation was then halted for almost two years to help exporters weather a global recession.

The yuan’s 31 percent advance in almost seven years makes it the third best of the most-traded Asian currencies tracked by Bloomberg, excluding the Japanese yen. The Brazilian real jumped 28 percent, while India’s rupee declined 16 percent and the Russian ruble dropped 3.3 percent.

Yuan May Weaken

Nobel laureate Joseph Stiglitz told reporters that the yuan may weaken as China takes steps to increase the ability of its investors to invest abroad.

“Opening up the band in conjunction with other actions they’ve taken may lead to a fall in the exchange rate rather than appreciation,” he said yesterday in Berlin, where he’s attending an economics conference. “To the extent they do open up, money may leave and that will weaken their currency. A free market exchange rate may not go in the way the U.S. thinks it should.”

The central bank said the widening of the band is to meet “market demands,” promote price discovery, and enhance the currency’s two-way flexibility. The change improves a managed, floating exchange-rate regime that is based on supply and demand and operates in reference to a basket of currencies, it said.

The monetary authority will keep the currency “basically stable at an adaptive and equilibrium level,” to preserve the stability of the Chinese economy and financial markets, it said.

Soft Landing

Twelve-month non-deliverable forwards for the yuan were 0.5 percent weaker than the onshore spot rate at the end of last week, according to data compiled by Bloomberg, suggesting that the currency could fall over that period. The yuan is already down 0.14 percent against the dollar this year.

“China will avoid significant appreciation or depreciation this year,” Lu Ting, an economist at Bank of America Corp. in Hong Kong, said after the announcement, citing reasons including an “uncertain” global economy.

“It adds to my confidence in a soft landing,” Goldman Sachs Asset Management Chairman Jim O’Neill said in an e-mail. The change is positive for equities because it shows reformers are “in charge,” while “for FX it just means more volatility,” he said.

Cliff Tan, a currency analyst at Bank of Tokyo-Mitsubishi UFJ in Hong Kong, said yesterday he’s leaving unchanged a forecast for the yuan to reach 6.17 by the end of 2012.

The U.S. House of Representatives has yet to take up a bill passed on Oct. 11 by the Senate, which would allow sanctions on countries with so-called misaligned exchange rates. Treasury Secretary Timothy F. Geithner said on Jan. 27 that China’s currency is “still below almost all measures of fundamentals.”

Trade Deficit

The U.S. trade deficit with China rose 8 percent to $295 billion last year, fueling friction between the two nations.

Mitt Romney, the Massachusetts governor who is seeking nomination as the Republican presidential candidate to run against Democratic President Barack Obama, is committed to applying “strong and sustained pressure” on China to overhaul its trade and currency practices, according to a statement released today from his spokeswoman.

“Even as our trade deficit with China has grown each year, President Obama has made no progress confronting China on its wide range of unfair trade practices,” said Andrea Saul, Romney’s spokeswoman.

PBOC Governor Zhou Xiaochuan said March 12 that market forces are playing a greater part in determining the yuan’s value, which is also affected by the balance of payments. China may “appropriately” widen the trading band to better reflect market supply and demand, the official Xinhua News Agency reported Zhou as saying on March 5.

Growth Target

China will aim for a 7.5 percent economic expansion this year, having had an 8 percent goal in place since 2005, Premier Wen said on March 5. Growth slowed more than forecast last quarter to the least in almost three years, with the economy expanding 8.1 percent from a year earlier, a statistics bureau report showed last week.

Before yesterday’s announcement, views had varied on how far the central bank could or should expand the trading band.

One option is an increase to as much as 2 percent, China Business News reported on Dec. 9, citing Liu Yuhui, a researcher with the Chinese Academy of Social Sciences. A band of 0.7 percent or 0.75 percent would be appropriate, Li Daokui, then a central bank adviser, said March 6.

To contact Bloomberg News staff for this story: Zheng Lifei in Beijing at lzheng32@bloomberg.net; Fion Li in Hong Kong at fli59@bloomberg.net

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net

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