The widening of the daily band within which the yuan can trade against the U.S. dollar is another small step towards making the currency convertible. The timing of the announcement by the People’s Bank of China that the band will be widened to 1% from 0.5% was no accident. It came just ahead of the IMF and G-20 meetings in Washington, where Beijing is usually criticized for keeping its currency undervalued. Announcements intended to draw some of the sting from such criticisms is not uncommon on Beijing’s part.
Yet nor should this latest one be unexpected. The current five-year plan sets expanding the use of the yuan in cross-border trade and investment as a goal, as it does the widening of the capital account, the two going hand-in-hand. The latest announcement also follows in increase in the quota of Chinese stocks and bonds foreign investors can buy, a raising of the ceiling on offshore yuan that can be invested domestically, and, as part of the Wenzhou experiment, the ability of Chinese investors to put excess savings abroad.
The yuan has risen by almost a third since its hard peg to the dollar was broken in 2005 and by 8.3% since 2010 when a temporary peg imposed after the 2008 global financial crisis was removed. Prime Minister Wen Jiabao has recently talked of the currency nearing equilibrium with the dollar. Not all China’s trading partners agree, particularly China bashers in the U.S. who say that Beijing keeps its currency undervalued to protect its exporters. Reminder to protectionists: currency movements can be driven by investment as well as trade flows. If more investment moves offshore from China as a result of loosening currency controls, then the yuan may fall against the dollar, not rise as its critics clamor for. The new trading band gives it room to move either way in response to market demand.
Criticism of China’s exchange-rate policy looks increasingly out of date. The battle is no longer only over exports. The longer war is over which currency will become the world’s dominant one, the dollar or the yuan. The yuan has to become fully convertible first. Though it still has a long way to go even to challenge the dollar let alone eclipse it, this latest round of currency-control loosening takes it another few steps down that path.