China keeps many currency controls intact

Elaine Kurtenbach

Monday, July 25, 2005 | 9:22 a.m.

BANGKOK, Thailand -- Having in one deft move ended the dollar link that anchored the Chinese economy through years of meteoric growth, Beijing is tackling its next big task: managing expectations of what comes next.

China's central bank governor launched into that job over the weekend, warning that the decision to link the value of the Chinese yuan to a "basket" of currencies, instead of just the dollar, and to raise its value by 2 percent, to 8.11 yuan per dollar, was no cure-all for the U.S. trade deficit.

"China's exchange rate reform won't have too much influence on U.S. deficits," Zhou Xiaochuan, governor of the People's Bank of China, told a conference of bankers on Saturday.

The United States and China's other trading partners have been pushing Beijing for years to let the yuan rise, saying it was undervalued by up to 40 percent, giving Chinese exporters an unfair price advantage.

Engaged in the precarious act of balancing demands from its trading partners for a stronger, freer yuan with their own desire for control, China's secrecy-obsessed communist leaders chose a compromise that raises as many questions as it answers.

The announcement by the People's Bank of China late Thursday did not say what currencies would be used to determine the value of the yuan, also known as the renminbi, or "people's money" -- or exactly how the system would be managed.

Despite vows of greater flexibility, what is clear is that most of China's currency controls remain firmly in place. Trading in the yuan is limited mainly to exchanges for trading purposes only -- a constraint meant to stave off potentially destabilizing speculative dealings while also preventing Chinese investors from freely shifting their savings overseas.

"The People's Bank will strive to raise its level of control and regulation, improve foreign exchange management and maintain a basic stability of (the) renminbi exchange rate," the Communist Party newspaper People's Daily said in a published interview with an unnamed central bank spokesman.

For more than a decade, from early 1994 until Thursday, the yuan's value was kept trading within a narrow band around 8.28 to the dollar.

The new system allows it to trade within a range of 0.3 percent on either side of the yuan's daily level -- a figure to be determined not just by the basket of currencies, but also by the trade surplus, economic policy needs and the ability of Chinese companies to adjust to exchange rate fluctuations, the central bank spokesman said.

In theory, the yuan could rise significantly over the coming months if the central bank allows its value to shift within the limits it specified. But appearing to underscore the authorities' determination to maintain control, the yuan barely budged from its new opening price of 8.11 to the dollar, closing Friday at 8.1111.

That means that compared to where it was trading the previous 10 years, the yuan rose in value by about one-quarter of a U.S. cent to 12.33 cents.

"It's not necessary to disclose our operations," a bank spokeswoman said, speaking on customary condition of anonymity, when asked if the central bank had bought U.S. dollars to keep the dollar/yuan rate stable.

Speculation over possible future revaluations persists.

Discounts on nondeliverable forwards, a key measure of expectations of the yuan's future value that does not affect actual exchange rates, on Friday suggested traders believed the yuan will rise 5.3 percent against the dollar within a year's time. That compared with a rate late Thursday reflecting expectations for a 6.1 percent rise in the yuan's value.

Traders said hedge funds and other currency market players expect the yuan to further appreciate against the U.S. dollar.

Although Zhou, China's central bank governor, insisted Beijing's maneuver was decided entirely for China's own purposes, "not a result of discussion and consultation with others," it's an aptly timed goodwill gesture ahead of Chinese President Hu Jintao's planned visit to the United States in September.

Whether it will be enough to satisfy critics of China's gargantuan trade surplus with the United States, which hit a record-high $162 billion (124 billion euros) last year, remains to be seen.

"Will this appease the hawks in the U.S. toward the Chinese trade issue?" Jonathan Anderson, an economist for UBS, wrote in a research note Friday. "It will probably be touch and go on this one and only time will tell," he said.