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People’s Bank of China expected to revalue Yuan to curb inflation

April 21, 2011

Will they or won’t they? They question has currency analysts sitting on the edge of their chairs, anticipating an approximate 10 percent appreciation of the yuan to cool down inflation even as interest rate rises and higher bank reserve requirements show limited success.  JP Morgan has said that it expects the year-end dollar/yuan forecast at 6.3, with policy adjustments to be announced in the next few months. On Wednesday, China’s central bank, the People’s Bank of China, set the dollar-yuan central parity rate at 6.5294, down from Tuesday’s 6.5346, to take into account the dollar’s weakness overseas.

Even as the yuan hit a 17 year high against the dollar this week, consumer prices have continued to rise, with the Chinese inflation rate reaching 5.4 percent last month, and the country’s foreign currency reserves ballooning to over US$3 trillion as the People’s Bank of China manages a very gradual appreciation of the yuan’s peg against the dollar.

Recent, official statements by senior Chinese leaders now seem be giving vent to what the US and India have been lobbying for all along – an appreciation of the yuan to tame inflation and decrease trade deficits. Chinese Premier Wen Jiabao said earlier this month that China will make the yuan more flexible as part of efforts to fight inflation. Xia Bin, an adviser to the PBOC, said Tuesday he doesn’t rule out another one-off revaluation of the yuan, and the currency’s trading band may be increased.

Looking at the yuan as an anti-inflation tool, Beijing is keen to avoid imported price pressures. As a result, by letting the currency rise more rapidly, the People’s Bank would not only be able to reduce dollar purchases that are starting to undermine its ability to manage domestic monetary policy, but it would lower the cost of raw materials from abroad.  Yuan-denominated transactions now account for 7 percent of Chinese foreign trade,  a sharp rise from only 0.5 percent a year ago and points to the growing importance of the Chinese currency.

While the question of a revaluation seems evident sooner rather than later, analysts are also pondering the impact of a one off revaluation or a staggered, more gradual revaluation. In a study, quoted by the Wall Street Journal, one  of the options, by Bank of New York Mellon’s keen China-watcher, Simon Derrick, warns that while gradual acceleration might be less disruptive for Chinese exporters, it would encourage more inflows into the country. Instead, he suggests, China might be better off with a one-off revaluation that surprises the market, keeps a lid on inflows, and acts as a more aggressive inflation-fighting tool. Meanwhile Tommy Xie, an OCBC Bank economist told China.cn.org “I doubt China will go for a one-time revaluation as I do not see the revaluation being able to help China solve the issue of a massive capital inflow, given that global markets still have excessive liquidity.” “We do not see a huge possibility of a yuan revaluation in the near term. Our view that the yuan will appreciate gradually remains intact,” Xie dded.

Before the BRICS summit last week where China implored the rest of the emerging economies to make the Yuan the regional traded currency of choice, India’d Reserve Bank of India  took on China’s trade deficit and urged Beijing to revalue its currency. In the paper entitled – ‘The Implications of Renminbi Revaluation on India’s Trade’, S Arunachalaramanan and Ramesh Golait of the Reserve Bank of India, the nations Central Bank have said that an artificially undervalued currency gives China a distinct advantage in the export market. The recently released staff report quoted – “By keeping RMB (renminbi) undervalued against the USD and depreciating it in line with the USD in the international market without taking into account the economic fundamentals of China, it invariably and distinctly provides competitive advantage over its trade competitors and trade partners including India”.

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