Beijing keeps coy on yuan's pace of appreciation
The yuan showed a bigger swing than usual against the US dollar last week, as Beijing apparently orchestrated a little bounce around the release by the US Treasury of its semi-annual currency report.
As expected, it did not label the mainland as a 'currency manipulator', rejecting demands from the US Congress, which is preparing legislation to impose trade sanctions.
US Treasury Secretary Paulson clearly understands that patience is the best way to avoid a protectionist trade war that would hurt the world economy and Beijing no doubt appreciates his diplomatic approach over the more confrontational attitude of many US Congressmen.
There is the possibility that his methods might have encouraged Beijing to allow faster yuan appreciation. But the mainland's Foreign Ministry spokesman Qin Gang said: 'As for whether the yuan exchange rate is high or low, the US Congress believes it is too low, but whose standard is this? It's the United States'. But ultimately China's yuan exchange rate must suit Chinese realities.'
Last week's rise was just another example of the way Beijing has been yo-yoing the yuan for its own political needs. The People's Bank of China steered the yuan higher last week by setting its midpoint for daily trading sharply higher for several days after pushing it lower during the previous three sessions. The whole point apparently was to set up the biggest multi-day bounce since the unpegging and revaluation in July 2005 just as the US Treasury unveiled its report. The gesture was a replay of the pattern of stepped up appreciation surrounding the visit to Beijing by Mr Paulson in September.
A more recent example was the central bank's announcement on May 18, in the run up to a high-level economic summit between US and mainland officials, that it was widening the daily yuan-US dollar trading band to 0.5 per cent on either side of the midpoint.
Never mind that the yuan never neared exploiting the 0.3 percentage point daily trading band in place previously. In the three weeks to May 18, when the yuan appreciation showed some acceleration ahead of the meeting, it rose just 0.7 per cent.
Reacting to the widening, the ever diplomatic Mr Paulson said he would 'choose to take it as a positive signal. The real test will be how much flexibility we see over time'.
By last week, cumulative yuan appreciation versus the greenback reached 6.3 per cent on top of the initial 2.1 per cent revaluation two years ago. It has gained around 4.2 per cent in the nine months since September (an annual rate of about 5.5 per cent), far exceeding cumulative appreciation during the previous 15 months.
The modest appreciation so far has had limited impact on the mainland's robust trade performance, which showed a surplus of US$85.8 billion in the first five months of this year, nearly double the US$46.8 billion for the period a year earlier, and on pace to exceed the record US$177.8 billion annual total for 2006.
This causes market pressure for yuan appreciation, which the government continues to resist through foreign exchange intervention, thereby accumulating reserves. Reserves jumped US$135.7 billion during the first quarter, twice the average quarterly increase in 2006, and reaching US$1.2 trillion in March. In an effort to help contain its swelling balance of payments surplus, the mainland last month announced a broadening in its so-called Qualified Domestic Institutional Investor programme, launched last year to promote capital outflows. The arrangement, which enabled banks and fund managers to invest just in overseas fixed income and money market instruments on behalf of clients, was expanded to include overseas equities, which should enhance the appeal of the programme.
It might actually kill two birds with one stone, not only helping trim the balance of payments surplus, but perhaps also providing an outlet for speculative funds that might otherwise contribute to a potential bubble in domestic equities.
The forex market, meanwhile, largely shrugged off the roller coaster in the equity market in the past few weeks. This followed the tripling in the mainland's stamp tax on securities transactions to 0.3 per cent on May 30, in an effort by authorities to cool speculation, after the Shanghai Composite Index has more than tripled since the start of 2006, raising fear of a potential bubble that might destabilise the economy.
If Beijing does allow faster yuan appreciation, it would be because as the mainland economy is showing renewed momentum and accelerating inflation, officials would want to help head off the potential for economic overheating. That is why, for investors in yuan, the key is watching what is happening on the mainland, not Washington.
