Thursday July 21, 2005 - 14:09:51 GMT
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INVESTICA Ltd - www.investica.co.uk
China revalues - is it a crawling peg?
The Chinese policy change will not satisfy overseas demands for change and there will be economic pressures for further yuan gains. Making the initial move is, however, important as it will be easier to take subsequent steps to offer increased freedom and a stronger yuan.
Further clarification will also be needed, but it could be that the Chinese central bank will effectively be using a crawling peg. Upward pressure on the yuan would result in a stronger trading band for the following day. Using this mechanism, the trading band could gradually be adjusted stronger by as much as 0.15% per day and this would gradually strengthen the yuan on a trade-weighted basis and against the US currency.
There is the potential for further medium-term appreciation and the Chinese move will also tend to strengthen Asian currencies in general. The overall implications for the Euro should be mixed, but will lessen the potential for strong Euro gains in the medium term.
China moves to currency band
The Chinese authorities have finally moved to adjust the yuan currency regime after months of political and economic pressure for a change. The yuan issue has also been a persistent area of market interest during 2005.
The Chinese central bank has announced that the yuan will now be linked to a trade-weighted basket rather than linked to the US dollar alone. In an initial move, the yuan has also been revalued by just over 2.0% so that the initial yuan value will be set at 8.11 against the US currency compared with 8.28 previously. The Chinese currency will be allowed to trade within a 0.3% band against the US currency while the fluctuations against the other currencies will be announced later. There will, however, be no real scope to adjust the yuan rates against the other currencies independently unless there are constant changes to the weightings of the other currencies in the basket. The closing rate of the relevant day will then be used as the central reference rate for the following day. This is potentially important as it could offer a mechanism to allow a crawling-peg yuan appreciation.
The yuan revaluation will not have a significant short-term economic impact. The move is, however, important as it has broken the period of inertia. The Chinese central bank has also stated that the band will be adjusted according to needs and according to the Chinese economic and financial situation. It is the case that the first step is the hardest to take and the authorities will be able to widen the band over the next few months according to the trade and capital account developments.
The near-term impact on the US trade account will also be limited and there will be pressure for further yuan strengthening and an eventual move to a free float. The Chinese move will, however, be important in reducing political stresses between the US administration and the Chinese officials. This will also reduce the potential for aggressive trade sanctions against China.
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