Unified yuan forecast to bring market uncertainties

THE unification of yuan exchange rates may result in a volatile yuan, exodus of funds and inflationary pressure in China, warns an economist with a large mainland-funded corporation in Hong Kong.

Lin Jiang, deputy general manager of the finance centre at China Merchants Holdings, said, however, the measure was necessary for the establishment of a modern foreign exchange system in line with international practices.

Speaking at a seminar yesterday, Mr Lin said during the process of establishing a national foreign exchange centre and unifying exchange rates, the yuan would be subject to devaluation pressure.

He said that under the old foreign exchange system there were many foreign exchange swap centres whose membership was restricted.

He also said that markets the centres had to serve were smaller.

''Therefore, the People's Bank of China could stabilise the yuan exchange rate more effectively by going into the market separately,'' Mr Lin said.

Following the unification of exchange rates and the establishment of a unified centre, he said the single market was much larger, and this made the task of the central bank in stabilising the value of the yuan more difficult, because there was a gap between supply and demand.

Mr Lin, also deputy director of the Hong Kong-Macau Research Centre at Zhongshan University in Guangzhou, said the new foreign exchange system might fuel price rises.

He said enterprises which relied on imported raw materials and machinery would be affected by the depreciation of the yuan.

''Depreciation would push up the production costs of enterprises which use imported raw materials and machinery, resulting in higher product prices,'' he said.

If the products were for domestic consumption, the cost of living in China would rise, and a corresponding adjustment in wages would be necessary, he said.

Galloping inflation would occur with wage increases and price levels would go up in turn, he said.

Mr Lin said because China would continue to see rapid economic growth, inflation would remain at a high level and the trade deficit would not be immediately reversed.

''Although the exchange rates have been unified, new administrative measures will be inevitable if demand for foreign exchange remains strong. Therefore, it is still possible different exchange rates will occur under the new foreign exchange system,'' he said.

Mr Lin believes the yuan exchange rate will remain stable in the short term.

But in the medium-and long-term, the stability of the yuan depends on fundamental factors such as inflation, the balance of trade and interest rates in China.

Beijing appeared to have the will to rein in inflation, and was controlling the supply of money as the main measure against inflation, he said.

Whether it would effectively contain inflation would be determined by the implementation of reforms in other sectors, he said.

As for Hong Kong investors, Mr Lin said the cost of investing in China would be lower under the unified exchange rate system.

Under the old system foreign investors' capital was exchanged into yuan using the official exchange rate, but now the market rate, which has appreciated about 50 per cent against the official rate, is used.

Mr Lin also said that under the new system, all enterprises would have equal access to foreign exchange, making competition fairer.

In the past, some state-owned enterprises were able to obtain foreign exchange at the official rate, while others had to buy foreign exchange in the swap centres.

The downside of the new foreign exchange system is that the volatile yuan has created uncertainty for investors.

Many projects are long-term investments relying on yuan revenue, such as infrastructure facilities, retailing and real estate.

''Previously investors had hedging instruments to avoid exchange rate risks, and revenue from the projects could be offset by a depreciation of the yuan,'' Mr Lin said.