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SCMP Reporter

AS financial markets prepared for an expected round of hefty increases in mainland interest rates, the yuan continued its astonishing recovery on the Shanghai swap markets yesterday, fuelling suspicion that the Bank of China was intervening to push it up still further.

   As the rate against the US dollar jumped from Monday's close of 9.557 to 8.4 yuan, analysts described its recent strength as ''amazing''.

   Although the 16-point action plan announced over the weekend to cool the economy was still being seen as good for the currency, some analysts suggested that the sheer size of the rebound pointed to a helping hand from the Bank of China.

  Slowing imports were also being reflected in the yuan's recovery.

  The view that China's trade deficit was widening, and threatening further currency problems, was wrong, according to Stella Fung of Schroder Securities.

   The trade deficit was actually falling, she said, although the six-month figures released on Monday appeared to be worsening rapidly.

   Import growth, which was responsible for the trade deficit of US$3.6 billion in the first six months of this year against a surplus of $838 million in the same period last year, was already slowing, she said.

   It was down significantly from 33.7 per cent in May to a modest 8.9 per cent last month.

   ''Imports started to slow even before the Chinese Government introduced tough measures to cool the overheated economy,'' said Ms Fung, adding that while trade would stay in the red, slowing imports would narrow the gap.

    Yesterday's rise took the yuan to 23 per cent above the low of 10.92 to which it sank in mid-June following Beijing's decision to allow it to float on the swap markets.

   Geoff Lewis, economist with Smith New Court (Far East), said it appeared the authorities had taken an opportune moment to use some of the available US$40 billion of reserves to add further weight to the yuan's recovery.

  ''It looks as if they have the heavy artillery in there, but I am surprised they want it to go back so quickly. If it is being driven largely by the reserves, they have done too much too soon.''    While many governments have found that supporting their currency has been a waste of money - with the reserves running out before the patience of the bears - China's illiquid market makes it much easier for the authorities to intervene successfully.

    Salomon Brothers economist Andrew Freris also said the recovery had over-run. ''8.50 or better is just too good to be true,'' he said, but added the fall to 10.92 had also been overdone.

   A rate of 9.50 yuan to the dollar would reflect reality, he said.

   Wardley senior economist Alfred Wong said the recent charge in the yuan reflected the arrival of Executive Vice-Premier Zhu Rongji as head of the central People's Bank of China and the unveiling of the 16-point plan to cool the economy.

   In Beijing, officials credited their policies for the revival. ''Our policy of freely floating the yuan has shown to be a success,'' Liu Guangcan, an official at the State Administration of the Exchange Control's policy department, told the Bloomberg financial news service.

   He said Beijing's attempts to rein in credit had finally paid off. The credit squeeze had forced companies to liquidate their cash reserves.

     ''As the supply of money is tightened, the regions will need more domestic currency to continue investments and less hard currency for imports,'' Mr Liu said.

   But in Hongkong, analysts agreed that it was probably too soon for the directives to the banks to squeeze their customers and cut out speculative loans to have taken effect.

   Now they are waiting for action from Mr Zhu to further tighten money supply by raising interest rates.

    How far he will go is the question. Mr Freris forecast the rise would be steep as the authorities attempted to impose real interest rates on the country.

   That would mean pushing them up from around nine per cent to more than the current rates of inflation, which vary from 12 per cent to an estimated 20 per cent in some industrial areas.

  There were even suggestions circulating, according to Mr Lewis, of a system of differential interest rates which would vary according to the local inflation rate. The concept would be hard to implement, he reckoned.

   But with more bad news on inflation expected soon, the authorities will have good reason to crank up interest rates, and Mr Freris said it was possible that jumps of three points at a time could be on the way.



Yuan regains more ground