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Yuan breaks key 8.0 to the dollar

(AFP)
Updated: 2006-05-16 10:04

China's yuan strengthened to close below the psychologically important eight to the dollar for the first time since last year's revaluation aimed at greater exchange rate flexibility.

"There's definitely a trend for the yuan to rise in value in future," said Sun Lijian, an economist at Shanghai's Fudan University. "But it's not going to be as fast as many believe."

There is only so much change the Chinese economy can absorb and the banking sector in particular needs a stable environment to carry out much-needed reform, he argued Monday.

The yuan ended at 7.9976 to the dollar on the local currency exchange after a parity rate of 7.9982 had been announced by the National Foreign Exchange Center early in the day.

In a joint statement after a Sino- European Union financial dialogue Monday, Beijing reiterated that it would continue to free up the yuan but again refrained from revealing the pace.

"China will further improve the yuan exchange rate formation mechanism and constantly make the exchange rate more responsive to market supply and demand," the statement said.

China will "strengthen aggregate control, improving the credit structure with market instruments, advancing the yuan exchange rate regime and market-based interest rate reform."

It is 12 years since the yuan -- under a different foreign exchange regime -- was last traded at this side of the 8.000 level. The strengthening comes amid persistent calls for China to act to cut its massive trade surpluses.

"There's a lot of money floating around the world these days," said Zuo Xiaolei, chief economist with Galaxy Securities. "And it's already a while since the yuan started being seen as an asset set to appreciate."

However, the forces of international finance are up against a powerful player in the form of the Chinese state in all its fierce determination to keep the yuan under control.

China officially allows market forces a say in determining the exchange rate, but only permits the yuan to fluctuate inside a 0.3 percent band around the dollar parity rate within each trading day.

The central bank is known to intervene routinely and heavily and the appreciation since July's revaluation has been at a snail's pace -- disappointing those, chiefly the United States, who had hoped for faster change.

Many economists believe the rate at any particular point in time reflects not so much supply and demand in the market, as policymakers' wishes -- specifically for the yuan to strengthen in a controlled and gradual fashion.

"The timing is good," said Andy Xie, Hong Kong-based chief economist with Morgan Stanley of the key move through the 8.00 yuan barrier.

"It gives the impression that the action taken is not under the pressure of outsiders but just a normal action."

He noted that the move on the yuan followed the release last week of a semi-annual US Treasury report into global currency policies which stopped short of labeling China a currency manipulator.

The move also followed the politically charged visit of President Hu Jintao to the United States last month when his agenda was topped by trade and currency issues.

A US finding of manipulation could have opened the way for sanctions against Beijing on the yuan, which Washington feels is massively undervalued and gives China an unfair trade advantage.

Beijing has insisted that while it wants to move to a more market-based forex system, any change will be gradual and measured against its own best interests.

The central parity rate is a weighted average price based on offers made each morning by the 11 market makers in the over-the-counter market.

Last July Beijing scrapped the yuan's 11-year-old peg to the dollar in favor of a link to a basket of currencies, allowing it to rise 2.1 percent against the US unit to give an initial level of 8.11.

The modest, one-step move was intended to rein in hot money inflows, reduce the cost of mopping up excess liquidity and publicly address the country's rising and politically sensitive trade surpluses, especially with the United States.

Since then the yuan has appreciated only by a fraction a day and well below the maximum percentages allowed under the basket system, sparking concerns Beijing would not allow the unit under the 8.00 yuan barrier.