The yuan is expected to strengthen only slightly next year as appreciation dynamics, including the mainland's export competitiveness, lose steam.
The Chinese currency was under the spotlight this year because it depreciated for almost the same number of days as it appreciated in the first 10 months of the year, in sharp contrast to the steady advance it had shown since exchange rate reform was put back on track in June 2010.
The zigzag progress has now left the yuan about 1 per cent stronger against the US dollar so far this year, after advancing against the greenback for 99 of the 201 trading days in the January-October period, retreating for 101 days and remaining unchanged for a day, according to the People's Bank of China.
"It will be trickier to predict the yuan rate next year, as there are risks from both sides [of appreciation and depreciation]," said Zhang Zhiwei, chief China economist at Nomura Securities. "However, I see no reason for a strong appreciation."
A trade surplus is the major force behind the yuan's 30 per cent-plus increase since the fixed peg to the dollar was abandoned in 2005. The mainland's current-account surplus accounted for 11 per cent of GDP in 2007, but the share is widely estimated to have sharply declined to less than 3 per cent this year.
China's exports were severely affected by slackening demand amid the European debt crisis this year. Although exports are expected to turn moderately better on an improved world economy next year, the declining trend of the surplus in the medium to long term is assured as China-made exports are losing competitiveness in world markets, according to Zhang.
"China's annual export growth used to be around 30 per cent before 2008, compared with the 5 per cent increase we expect for next year. The export sector is losing competitiveness and, for example, more Nike shoes are produced in Vietnam nowadays," Zhang said.
Because of higher labour and land costs, many multinationals are moving their plants from the world's manufacturing hub. The new leadership elected at the party's 18th national congress in November is also expected to focus on boosting domestic demand, shifting from the investment and export-oriented economic development model.
Foreign investment, another key dynamic behind a currency's strength, will also become less predictable in the future, according to Zheng Guihuan and Chen Shaomin, who are from the investment and statistics division of China's central bank.
Against the backdrop of world economic and financial turbulence, the contribution of the capital and financial-account surplus to China's GDP rose from 0.9 per cent in 2008 to 4.8 per cent in 2010, and then dipped to 3 per cent in 2011 before further dropping to 0.4 per cent in the first half of this year, official data showed.
"The appeal to foreign capital will remain in the next few years because of China's relatively fast economic growth," the two officials wrote in the latest China Finance, a bimonthly magazine of the central bank.
"However, attraction to labour-intensive companies will decrease with China's raised requirements on labour and environment protection. So foreign direct investment is expected to slow in the coming years," the two officials said.
Grace Ng, senior China economist at JPMorgan Chase Bank, forecast the yuan would advance by 1 to 2 per cent against the dollar next year.
"The exchange rate will be relatively volatile next year," she said. "It may weaken in the first half as the US dollar strengthens amid the uncertainty of the fiscal cliff, while the yuan's appreciation is likely to become more evident in the second half."
UBS expects the dollar-yuan fixing will remain largely within the 6.20 to 6.40 range next year, albeit with increased volatility. The exchange rate is allowed to diverge by 1 per cent in either direction from the central bank's daily midpoint.
The Chinese government probably had no intention of letting the yuan appreciate "steadily and consistently" in the coming year, given the continued uncertainty and weakness in the global economy, said UBS economist Wang Tao. "Fundamentally, it is difficult to argue that the yuan is much undervalued anymore as the current-account surplus is likely to stay low."
However, allowing for a visible depreciation of the yuan would also be unwise in the present international political environment, Wang added. "The government will probably allow more flexibility in yuan rates, perhaps widening the trade band to 1.5 per cent."
China maintains the yuan in a managed float with reference to a basket of currencies. In April, the central bank widened the daily trading band from 0.5 per cent to 1 per cent around the official reference rate, a step forward towards further liberalisation of the exchange rate.
Offshore forwards contracts have been more bearish towards the yuan than the currency's performance in the spot market this year. One-year non-deliverable forwards implied a depreciation in the next 12 months, quoted at around 6.31 per dollar on Thursday, a depreciation of over 1 per cent.
Central bank chief Zhou Xiaochuan has recently sounded a cautious note on the country's long-term liberalisation of its currency.
At a financial forum in Sanya, Hainan, two weeks ago, Zhou said Beijing was on course to gradually make the yuan fully convertible, but added it might have to resume capital controls if a financial crisis erupted.