Wider yuan trading a key reform step

Beijing has a knack for making policy announcements when they are most likely to add to the nation's political capital. True to form, the central government has widened the trading band of the yuan ahead of meetings in Washington of the International Monetary Fund, the World Bank and the G-20 summit. This is when China usually comes under pressure to allow the exchange rate to rise. The news also came as the US Treasury delayed a report on the exchange-rate policies of trading partners until after these meetings. During an election year in the US, the half-yearly report is usually a sign for China-bashing by populist politicians, who want the country branded a currency manipulator.

The exact timing may not have been random. But the move to allow the yuan to rise or fall 1 per cent from a preset reference level - double the present trading band of 0.5 per cent fixed in 2007 - has deeper significance than deflecting criticism from trading partners. It is, of course, an incremental step in the internationalisation of the currency that makes it more flexible. The People's Bank of China will not intervene in the market so long as the yuan stays within the wider trading band. But more than that, it shows a resolve to push ahead with economic reforms as part of efforts to internationalise the yuan and put future economic growth on a sustainable path.

The announcement came amid a decline in foreign direct investment and exports, due largely to the impact of the European debt crisis and a narrowing competitive advantage. These are a reminder that the mainland's growth model is exposed - along with employment and social stability - to external shocks. First-quarter growth has slowed to 8.1 per cent - the lowest in three years - and the central government has lowered its target for this year to 7.5 per cent, compared with 8 per cent since 2005.

To maintain employment and domestic consumption in the short term, Beijing will need to tweak monetary and fiscal policies. In the longer term, the Communist Party will have to endorse more fundamental financial reforms. These include breaking the stranglehold of the big state banks and state-owned enterprises and freeing up the flow of capital to small-to-medium private enterprises, the growth engine of employment.

Analysts differ over whether the lower GDP figure is a trend or the bottom before a rebound. China does usually overshoot the official target. One positive aspect was an increase in the contribution to growth of consumption, up from 51.6 per cent in 2011 to 76 per cent, while the share of investment in big projects fell sharply. Subject to the need to continue attracting investment, the numbers are an early boost for attempts to rebalance growth towards consumption.