Economic strength, political timetable behind yuan rise

At times like this, both can claim to have right on their side.

The yuan's rise against the dollar on September 14 to the highest level since it was revalued in July 2005 comes on the heels of another bumper trade surplus, which central bank deputy governor Hu Xiaolian recently identified as a major determinant of the exchange rate.

But the People's Bank of China is, tellingly, allowing the yuan's appreciation to gather pace in the very week when US lawmakers are scheduled to grill Treasury Secretary Timothy Geithner over what many of them see as a substantial undervaluation of the exchange rate.

IMF economists recently estimated the yuan's degree of undervaluation at between five percent and 27 percent.

The yuan, also known as the renminbi (RMB), traded as high as 6.7435 per dollar on September 14, up 1.2 percent since Beijing abandoned its quasi-fixed peg to the dollar in June.

But Bank of America Merrill Lynch calculates that the yuan has actually depreciated by one percent over the same period against a basket of currencies of China's major trading partners – the gauge highlighted by Hu in a series of five essays she published in July.

“What they are trying to do is make the market play a more and more important role,” Jianguang Shen, an economist with Mizuho in Hong Kong, said of the Chinese authorities.

“But at times they still keep a lot of control over the exchange rate, and the political effect will always be in their considerations,” Shen added.

Which is a good description of the “managed floating exchange rate regime” that China has been pursuing since 1994.

The tag is flexible enough to have accommodated a rigid peg for nearly a decade before the landmark 2005 revaluation; the yuan's steady rise of 21 percent against the dollar in the ensuing three years, followed by another two years of next to no movement during the global financial crisis; and now, since June 19, the resumption of gradual, unpredictable appreciation.

Whether the rate of climb will be swift enough to placate truculent US lawmakers is open to question, but the consensus among China-watchers is that economic fundamentals will justify a continued rise in the yuan regardless of political deadlines.

These include the October 15 date on which the US Treasury is due to make its next judgment on whether China manipulates its exchange rate, mid-term Congressional elections on November 2 and a summit of the Group of 20 major nations in Seoul on November 11-12.

Coincidentally or not, China dropped its dollar peg in June days ahead of the last G20 summit in Canada.

“Foreign pressure is a big factor, but it is not the only decisive factor. If the was slowing or if the trade surplus falling, then even with foreign pressure the yuan wouldn't change much,” said Zhang Bin, a researcher with the Chinese Academy of Social Sciences, a top government think tank.

The stars line up
In the event, China has notched up a trio of surprisingly strong monthly trade surpluses and growth has perked up.

“Just a month ago, there was quite a lot of pessimism. But now there's been a change and some people even think the economy will rebound in the fourth quarter,” Zhang told reporters.

Moreover, the dollar has been falling in recent days. “From a basket perspective, this means the yuan should be appreciating,” he said.

What's more, China is not seeing major inflows of speculative capital.

“If there was, the central bank would be a lot more conservative. So if you look at all of these factors, they are all supportive of an increase in RMB appreciation,” Zhang added.

Ting Lu with Bank of America Merrill Lynch in Hong Kong, broadly shared Zhang's analysis.

Sound fundamentals give China room to let the yuan rise a bit; the renminbi's nominal effective exchange rate – its performance against a basket of currencies – has fallen since June; and Beijing highly values its ties with Washington, Lu said.

“The most important bilateral for China is the United States, so I think they'll just give them some face,” he said.

Lu has a year-end target of 6.60 yuan per dollar, as do economists at JP Morgan, who cite China's plump trade surplus and renewed political pressure for the projected appreciation.

Shen at Mizuho has also pencilled in 6.60, but he said the rise could be greater if Beijing pays heed to fundamentals.

A Ministry of Commerce researcher at the start of September said that China's trade surplus could reach $150bn this year, handily outstripping the ministry's earlier forecast of $100bn. The surplus in 2009 was $196bn.

“Even $150bn may be on the downside. So with this big trade surplus, I don't see that there's any reason to hold the currency back,” Shen said.

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