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Beijing's 'Thursday
surprise'
By David M Lenard
HUA HIN, Thailand - At 8:00 local time on
Thursday, July 21, the People's Bank of China
(PBoC), China's central bank, released the text
reprinted here. The most important parts of the
Announcement of the People's
Bank of China on Reforming the RMB Exchange Rate
Regime
July 21,
2005
With a view to establish
and improve the socialist market economic system
in China, enable the market to fully play its
role in resource allocation as well as to put in
place and further strengthen the managed
floating exchange rate regime based on market
supply and demand, the People's Bank of China,
with authorization of the State Council, is
hereby making the following announcements
regarding reforming the RMB exchange rate
regime:
1. Starting from July 21, 2005,
China will reform the exchange rate regime by
moving into a managed floating exchange rate
regime based on market supply and demand with
reference to a basket of currencies. RMB will no
longer be pegged to the US dollar and the RMB
exchange rate regime will be improved with
greater flexibility.
2. The People's
Bank of China will announce the closing price of
a foreign currency such as the US dollar traded
against the RMB in the inter-bank foreign
exchange market after the closing of the market
on each working day, and will make it the
central parity for the trading against the RMB
on the following working day.
3. The
exchange rate of the US dollar against the RMB
will be adjusted to 8.11 yuan per US dollar at
the time of 19:00 hours of July 21, 2005. The
foreign exchange designated banks may since
adjust quotations of foreign currencies to their
customers.
4. The daily trading price of
the US dollar against the RMB in the inter-bank
foreign exchange market will continue to be
allowed to float within a band of +/- 0.3%
around the central parity published by the
People's Bank of China, while the trading prices
of the non-US dollar currencies against the RMB
will be allowed to move within a certain band
announced by the People's Bank of China.
The People's Bank of China will make
adjustment of the RMB exchange rate band when
necessary according to market development as
well as the economic and financial situation.
The RMB exchange rate will be more flexible
based on market condition with reference to a
basket of currencies. The People's Bank of China
is responsible for maintaining the RMB exchange
rate basically stable at an adaptive and
equilibrium level, so as to promote the basic
equilibrium of the balance of payments and
safeguard macroeconomic and financial
stability. | statement were
items 1 and 3, which said: "starting from July 21,
[the] RMB [aka yuan] will no longer be pegged to
the US dollar", and "The exchange rate of the US
dollar against the [yuan] will be adjusted to 8.11
yuan per US dollar at the time of 19:00 hours of
July 21, 2005."
Despite the deliberately
bland and enigmatic wording (the PBoC has
certainly graduated from the Alan Greenspan school
of baffling, Solomonic pronouncements), the
announcement sent shock waves through global
financial and currency markets and was expected to
cause significant readjustments in the global
economy.
China's abandonment of the US dollar peg
not only changed almost 11 years of currency
policy but directly reversed government statements
from only days before. China's soaring trade
surpluses and foreign currency reserves had
prompted foreign pressure to allow the yuan to
appreciate, and speculation that a move was
imminent reached fever pitch in mid-May.
But the PBoC successfully damped down such talk
over the last several weeks, only to catch
currency markets flat-footed with Thursday's move.
Thus, even if the revaluation itself had been
expected, its timing was not.
Beijing's 'Thursday surprise'
essentially consisted of two policy changes, each
significant by itself. First, where previously
8.28 yuan had bought 1 US dollar, as of July 22,
it only takes 8.11 yuan to buy a dollar; ie, the
yuan was allowed to appreciate 2.1% against the
dollar. Second, whereas the yuan had been
officially valued in terms of dollars and backed
only by dollars, China's currency is now valued in
terms of an adjustable "basket of
currencies".
Interestingly, the composition of the
basket was not defined (note the ambiguous
language in point 1, "a basket of currencies"),
although observers generally expected it to
include, at the very least, euros and Japanese
yen. This appeared to make China's currency policy
similar to that of Singapore, which also values
its currency in terms of a basket whose
composition may be changed by government fiat. It
is also noteworthy that the two steps were taken
at the same time; most observers had expected a
revaluation against the dollar first and a shift
to a basket-defined currency later.
Collectively, these measures allowed the
government to cautiously edge the yuan away from
the dollar, certainly a logical move given the
dollar depreciation of recent months. This was
accomplished not only by the basket measure, which
gives the PBoC latitude to strengthen the yuan
simply by redefining the basket as opposed to
buying US treasury bonds as it had in the past,
but also by the careful "such as the US dollar"
language in point 2, which, read literally, would
allow the bank to define the yuan in terms of any
currency it likes, while still implying that the
yuan would remain de facto predominantly
dollar-backed.
Will continuous
appreciation be allowed?
Point 2, which
states that the market close for the yuan value on
one trade day will become the "central parity" for
the following working day, coupled with point 4,
which establishes a +/- 0.3% range in which the
yuan's value will be allowed to float, appears to
open up the possibility of a steady stepwise rise
in the yuan over the next several weeks. This is
because the yuan is widely believed to be
undervalued by at least 20% in pure market terms,
and would therefore instantly appreciate by at
least that amount if freely traded; but since only
0.3% daily changes are allowed, any large
appreciation would have to occur in 0.3% daily
increments.
But
the government lost no time in preventing the
steady-rise scenario. First, the PBoC statement
itself says that "The PBoC is responsible for
maintaining the RMB exchange rate basically 
stable at an adaptive and
equilibrium level, so as to promote the basic
equilibrium of the balance of payments and
safeguard macroeconomic and financial stability."
"Basically stable" cannot possibly mean that a
large-magnitude rise will be allowed anytime soon.
Strengthening this notion, the yuan barely budged
early Friday from its opening rate of 8.11.
Currency traders said the central bank had been
buying dollars to prevent the yuan from
immediately zooming to the top of its band.
China's official media also poured cold water on
any expectations of further appreciation; a China
Daily editorial said pointedly Friday:
"Expectation for a bigger appreciation of the
yuan's value was, and will be, unrealistic." And
few currency market observers expected further
rises in the short term. Maxine Koster, economist
at CSFB, was typical: "I think that's probably it
for this year. We should see maybe some more small
steps next year. But nobody's going to [pressure]
the Chinese into doing it - they'll do it when
they're ready, which is shown by this move which
came out of the blue."
Fluctuation band
for other currencies set at 3%
Point 4 of
the Thursday announcement left unclear ("a certain
band") what the trading band for non-dollar
currencies would be in the new basket arrangement,
but this was later clarified by the PBoC; other
currencies will be allowed to fluctuate within a
band of +/- 1.5%, ie, a 3% band, according to AFX.
This was expected to give the central bank more
flexibility, noted Morgan Stanley economist Andy
Xie, who said that China could allow more
flexibility in the yuan's movements against these
currencies given that they will make up a much
smaller share of the basket than the US dollar.
Why now, why only
2.1%?
Thursday's announcement was a careful
compromise by a government that prizes stability.
Revaluation per se was expected; Chinese financial
officials have said many times in the past several
months that the country would eventually shift to
a more flexible, market-driven exchange rate
regime, so the question was actually "when", not
"if".
There are several possible reasons
for the surprising timing of the policy shift.
First, the government did not want to reward
speculators or give the impression that it was
giving in to speculative pressure. Although there
has in fact been large-scale buying recently of
yuan and yuan-denominated assets (such as domestic
real estate) in anticipation of revaluation, the
level of such activities had clearly flattened in
the last several weeks after a peak in May. So the
timing allowed the government to claim that it had
outsmarted the speculators. Second, recent economic figures,
which showed 9.5% growth in the first half of 2005
even after macroeconomic cooling measures, have
weakened one of the government's key arguments
against revaluation, namely that the Chinese
economy was still too fragile to easily adjust.
Third, China's financial reform measures have been
making reasonable progress (eg, with the recent
investments in the China Construction Bank by the
Bank of America and Temasek Holdings), and this
has helped to cool fears that the plans of state
banks to list on overseas stock markets could be
threatened by additional insolvencies created by a
large-scale revaluation. Fourth, revaluing now
will smooth the way for President Hu Jintao's
planned visit to Washington in two months. Fifth,
CNOOC's attempt to take over Unocal is at a
critical phase, and a revaluation could strengthen
the bid in two ways: financially, by increasing
the value of CNOOC's yuan holdings in dollar
terms, which could allow it to increase its bid;
and politically, by allowing China to claim that
it is accommodating US wishes over the yuan-dollar
exchange rate.
The small, 2.1% magnitude
of the revaluation, although unexpected, is
readily explicable in several ways. First, it will
allow the government to assess the ability of
domestic institutions to adjust to the new rate,
potentially easing similar adjustments in the
future. Second, the modest revaluation allowed
China to avoid the appearance that it was
capitulating to outside pressure from the US or
EU. Although past US critics of China's currency
policy, such as Senator Charles Schumer
(Democrat-New York), generally welcomed the move,
its magnitude was certainly far less than most of
them had asked for (most had called for a
revaluation of between 10 and 40%, and the 27.5%
tariffs on all Chinese exports to the US called
for by the Schumer-Graham bill was a figure which
specifically reflected the extent to which the
yuan was felt to be undervalued by the US
Congress). Third, a 2.1% adjustment was not felt
to be large enough to seriously threaten many
Chinese export firms, many of which operate with
minimal profit margins due to overinvestment in
sectors like textiles. Such companies, whose
products are now 2.1% more costly to their US
customers, can respond by increasing prices or by
cutting costs; some combination of both is likely,
but given the vast cost advantage Chinese firms
possess over their developed-country competitors,
it is unlikely that major changes in trade
patterns will materialize as a result of the
change.
The case against 'baby
steps'
Until Thursday, the conventional
wisdom was that any revaluation would be at least
5%. The main reason for this belief was that a
small revaluation would only increase speculative
pressure on the yuan by creating a self-fulfilling
perception that further revaluation moves are only
a matter of time. It was argued, in effect, that
pulling off the Band-Aid all at once would be less
painful than removing it slowly. Early Friday,
reports indicated continued strong demand for the
yuan and yuan-denominated assets, suggesting that
the fear of speculation was somewhat justified.
But the government's vigor in defending the new
rate showed that Beijing intends to do what it
takes to keep the lid on for the time being. With
the battle lines thus drawn, it will be
interesting to see how the exchange rate develops
over the next several weeks. If indeed the yuan
appreciates further, given the wording of the PBoC
announcement, Beijing can always claim that it
actually intended to allow additional
appreciation, "according to market development as
well as the economic and financial situation"
(point 4).
The international
reaction
As expected, important US figures
welcomed the move. Treasury Secretary John Snow
said: "I welcome China's announcement," and
Federal Reserve Chairman Alan Greenspan (whose
recent statement that revaluation would not
significantly alter the US employment picture was
widely noted) called it "a good first step", while
adding that further adjustments would be
necessary. Senator Schumer opined that "it is
smaller than we had hoped, but to paraphrase the
Chinese philosophers, a trip of a thousand miles
can well begin with the first baby step," adding,
"we expect more." His Republican colleague Lindsey
Graham also promised to keep up the pressure,
saying: "What paid off most was persistence, the
unwillingness to let the issue die." At the White
House, press secretary Scott McClellan said the
administration was "encouraged by China's
announcement,'' but President Bush himself,
despite giving a speech on trade in Washington
Friday, did not comment specifically on the
revaluation. Overall, while it appeared very
unlikely that Thursday's move by itself would
quell pressure for further revaluation, it
certainly weakened the position of those in the US
who have argued for stronger action.
Outside the US, reaction was generally
positive. Malaysia broke its peg to the US dollar
almost immediately after the announcement,
suggesting a government contingency plan had been
in place for a yuan revaluation. Hong Kong,
however, maintained its dollar peg for the time
being. The monetary authority of Singapore (MAS)
said that the change would not have a major impact
on the Singapore dollar or the country's exchange
rate regime. In Australia, observers considered
the move likely to boost Australian exports to
China; JP Morgan China economist Stephen Walters
noted, "Australian exports should get a boost as
China's purchasing power increases," although he
cautioned that "so too will all other countries
exporting to China." Acting Prime Minister Mark
Vaile also lauded the effect on exports,
"especially on resources and agriculture
products". In Thailand, the Bank of Thailand (BOT)
welcomed China's decision, saying in a statement
that it fully supported the policy change, and
that the increased flexibility comes at an
opportune time and it believes that the move will
be of great benefit to both China and the global
economy.
In South Korea, most analysts
expected the move to have little immediate impact,
although economist Koh Yu-seon at Korea Investment
& Securities commented that the yuan
revaluation might help ease inflationary pressure
in China, improve purchasing power there, which
would in turn help south Korean exporters. Japan's
Chief Cabinet Secretary Hiroyuki Hosoda said
cautiously, "[the revaluation] must be the
conclusion of the Chinese government having
considered various things. We pay our respects to
that ... I think it is the first step toward
[China's] economic globalization." In the EU,
French Finance Minister Thierry Breton said that
he was "delighted" by the revaluation decision and
welcomed the move as "positive", saying: "It's a
positive adjustment for the Chinese economy but
also for the euro zone ... this development, which
responds to the wishes of the countries of the G7,
is liable to strengthen the financial stability of
the world economy."
Near-term
effects
Most Asian currencies strengthened
against the US dollar Friday in tandem with the
yuan. Chinese stock markets rose due to a
perception that the more flexible currency regime
will make Chinese assets more attractive to
buyers, even though it simultaneously made those
assets more expensive in foreign currency terms.
Within the Chinese market in early trading Friday,
airline stocks rose while textile stocks fell;
Chinese airlines will benefit from the country's
increased buying power for dollar-denominated
aviation fuel, while textile makers will suffer
from increased prices for their products overseas.
In the US markets, bond yields were expected to
rise because the anticipated reduced buying from
China, a major purchaser of US bonds, will force
bond issuers to raise yields to maintain the same
level of sales. In the currency markets,
commodity-dependent currencies like the Australian
dollar, the Canadian dollar, and the Norwegian
kroner were predicted to rise due to China's
heightened purchasing power for these countries'
commodity products. In addition, many observers
expected improved results for multinational firms
operating in China, because the revaluation made
their China-based profits worth more in terms of
their "home" currencies.
David M
Lenard is a correspondent for Asia Times
Online in Thailand.
(Copyright 2005
Asia Times Online Ltd. All rights reserved. Please
contact us for information on sales, syndication and republishing.) |
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