Tag Archives: foreign exchange

Yuan Shored Up Against Pressure From Washington And Tokyo

The U.S. Treasury has, as has become its custom, again declined to label China a currency manipulator. Its latest semi-annual report to Congress does say the yuan’s effective exchange rate remains “significantly undervalued” against the dollar, though it acknowledges that the Chinese currency has appreciated by 33.8% by that measure since currency reform started in 2005. It again calls for more exchange rate flexibility on Beijing’s part. All pretty much par for the course, and intended for domestic political consumption as much as anything.

More weight is given to its call for stronger policy changes on Beijing’s part to embed rebalancing. The Treasury remains concerned that the lessening of the surplus on the external account isn’t “enduring”. “Without more forceful structural reforms to promote domestic consumption, there is a risk that China’s imbalances will re-emerge as the global economy recovers,” it says. There would be little disagreement from this Bystander that further exchange rate reform is a necessary if far from sufficient condition for rebalancing.

In the meantime, the People’s Bank of China seems to have been intervening in the foreign exchange markets again on a large scale with activity intensifying since the fourth quarter of last year. The reversal in the slowing of foreign exchange reserve accumulation seen in the first three quarters of 2012 points to this.

This may as much as anything be being driven by the weakening of the yen ever since it became clear that Shinzo Abe would become prime minister last November. Though the official line in Tokyo is that the new government and its newly installed governor of the Bank of Japan aren’t targeting exchange rates, a weaker yen is a necessary precursor for the aggressive monetary policy aimed at achieving an domestic inflation target of 2% to work. Washington says it is monitoring the yen closely. With the yuan still closely tied by its 1% band to movements in the dollar, so is Beijing.

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Yuan-Yen Direct

Direct trading between the Chinese and Japanese currencies starts Friday, cutting out the dollar as an intermediary. Rates will be posted in Tokyo and Shanghai, with China’s monetary authorities allowing a 3% daily trading band for the yuan against the yen (the dollar gets a mere 1% band).

And so Beijing takes yet another step along the long road to the internationalization of the yuan. How long before the won joins in, a likely next step given the plans for a free trade agreement between China, Japan and South Korea?

There is no particular reason for trade not involving the U.S. to be exposed to the potential volatility of the dollar. Direct currency settlement should increase yuan settlement of China’s imports and exports, as it lessens the currency risk for Japanese and South Korean buyers of goods denominated in yuan. The same idea is behind plans for an agreement between China and its fellow Brics, Brazil, Russia, India and South Africa, to make loans in their own currencies to facilitate trade. The five Brics plus Japan and South Korea account for about 30% of world GDP, compared to 45% for the U.S., the U.K. and the Eurozone.

Greater use of the yuan in trade could eventually grow into full convertibility of the currency. Before then, though, there will need to be a loosening of China’s capital controls and more opening of China’s capital markets. Both represent a greater political challenge than expanding trade finance. Opponents of reform have been able to argue that China’s national interest has been well served by cross-border capital controls and the ring-fencing of the country’s financial system. Only beyond that still distant horizon lies reserve currency status.

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China: One Currency; Two Yuans

London has made more than one fortune on the China trade, though they have not all ended happily. Whether the yuan will end up as the new opium is the question raised by George Osborne, Chancellor of the Exchequer as the U.K. calls its finance minister, who has been in Hong Kong to promote a scheme to make London the leading international center for trading in China’s currency. London and Hong Kong have been talking about how to do this since last summer. Osborne’s trip will continue the talks.

Chatham House, a think tank in London, has forecast that trade transactions settle in the currency would reach the equivalent of $1 trillion by 2020. Yet, while Beijing has been taking baby steps towards making the yuan a fully convertible currency, there is still a long, long way to go. It remains an aspiration as much as anything but also a hostage to the pace of financial reform, which, as we have noted before, is in stasis during the leadership transition. China may need to rebalance its economy away from export- and investment-led growth and towards domestic consumption, for which financial system reform is a necessary if not sufficient condition, but vested political interests stand in the way. For all the wishful thinking in some parts, the Chinese currency is far from displacing the dollar as the world’s reserve currency, or even having the standing of the yen or the euro in such circles.

If anything, the surprise is that the offshore market for yuan is as large as it is (yuan deposits in Hong Kong total the equivalent of $80 billion). Normally the deepening and development of domestic financial markets and the easing of capital controls is prelude not postscript. In China, the first two are so difficult that the third is the easier option, even if by having a government controlled onshore yuan market in China and market driven offshore yuan market in Hong Kong and London, China may well end up, not untypically, with one currency but two yuans.

London, of course, will be happy to take its skim off both.

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Yuan Rising

By breaking through an exchange rate of 6.50 yuan to the dollar on Friday, China’s currency passed through one of those symbolic milestones beloved of market commentators. Thumbing through our records we see that level was last reached in 1993. A lot of Chinese exports have flowed under the bridge since then.

While a spurt of yuan appreciation usually precedes Sino-American talks (there is a round due in Washington mid-May), the People’s Bank of China seems now to be  belatedly letting the yuan shoulder more of the burden of fighting inflation, by making energy and food imports cheaper. The currency has gained almost a full percentage point against the dollar this month, as much as it was allowed in the whole first quarter. Since Beijing freed the yuan from its dollar peg in 2005, with a near two-year repegging after the global financial crisis hit in 2008, the yuan has gained 27.5% against the dollar under the central bank’s managed appreciation regime. Since it was unpegged for a second time in June 2010 the yuan has appreciated 4.6% against the dollar, though it has depreciated in nominal effective terms.

As the chart below, from the World Bank, shows, the yuan’ effect exchange rate has been trending up if not by as much as the nominal figures for its appreciation against the dollar might have one imagine. REER stands for real (i.e. inflation-adjusted) effective exchange rate (the value against a trade-weighted basket of currencies),  NEER for nominal effective exchange rate. Note the widening gap between the two since mid-2010 during which time exports have been resurgent.

The question for investors now is whether April’s appreciation against the dollar signals a willingness on the central bank’s part to step up the pace of appreciation of the currency in the face of stubbornly high inflation, or, as we suspect, just that it plans to continue to let the yuan rise as it has been doing.

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China Puts A Number On Hot-Money Inflows, And It’s Small

China’s policymakers have long pointed an accusatory finger at the impact of hot-money inflows on inflation and asset bubbles. To what extent that is true has been difficult to assess. Quantifying such speculative investment inflows is tricky. In essence, analysts look for foreign-exchange reserves not explained by traditional transactions such as trade and foreign direct investment.

The State Administration of Foreign Exchange (SAFE) has taken a stab. The numbers it comes up with are $75.5 billion for 2010, and, after netting out cross-border yuan settlement, $35.5 billion, which is equivalent to 7.6% of the year’s total increase in foreign-exchange reserves. By way of comparison, SAFE reckons, total hot-money inflows in 2009 were $29.1 billion and averaged $25 billion a year over the previous decade, accounting for the equivalent of 9% of annual foreign-exchange reserve increases on average. (The is no netting out number as cross-border yuan settlement is recent.)

The numbers suggest that hot-money inflows account for a relatively small part of capital inflows, and are but a spec compared to the size of the economy as a whole. They took a large leap last year and any extra irritant to inflation is unwelcome to policymakers struggling to drain the excess liquidity from the economy in a controlled and orderly way. They also suggest that China is having increasing difficulty in maintaining effective foreign-exchange controls.

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