China to slow yuan rises but repeg unlikely

China is set to show the world that its currency policy begins and ends at home, slowing down the yuan's appreciation to shield exporters from a global economic downturn and show US lawmakers they cannot push the pace of reform.
Beijing can argue that the economic fundamentals alone suit a period of currency stability, never mind that the US Senate would be up in arms after passing legislation designed to force the pace of appreciation, or that the world at large wants China to ramp up consumption to boost global growth.
Yuan forwards markets are pricing in a slower pace of appreciation for the currency against the dollar. Few analysts expect Beijing to repeg the yuan to the dollar, but instead see a temporary slowdown in its rise to ride out the global slowdown and make a statement to the United States. Beijing's worry is that the external backdrop becomes as bad as the summer 2008, when global financial turmoil put a then three-year long, 21 percent appreciation of the yuan on hold.
Latest figures show that Chinese economic growth is its slowest in two years, the pace of exports is wilting and the flow of capital into the country is slowing down. Export growth to the euro zone, China's biggest export market, more than halved in September from August and exports were a net drag on the economy's growth in the first three quarters of this year.
Meanwhile, Beijing can make the case that the 7 percent gain against the dollar chalked up since the last pause in the currency's appreciation ended in June 2010 has kept consumption robust, as demonstrated by September's 17.7 percent year-on-year jump in retail sales.
Crucially, China would get to stand fast against its main rival, the United States. If it bows too quickly to US demands to let the yuan strengthen, millions of Chinese may take offence and so set off alarm bells in stability-obsessed Beijing. A short-term halt to appreciation versus the dollar might be a suitable political reminder that with every new yuan-trade settlement bilateral-currency-swap deal signed with co-operative trading partners, China makes the dollar incrementally less important in international trade and global currency reserves.
"For our own interests, we think that the yuan's further rises should be curbed given the risk that the United States and Europe could slip into a recession," said Wang Jun, an economist at CCIEE, a government think-tank in Beijing. "Also, we don't want to be seen as yielding to foreign pressure and we have room to resist such pressure," he said.
Still, such heavy handed intervention to manage the yuan would also be a reminder to China's trading partners of the risks of adopting the currency in their trade settlement.
POLICY LEASH TO TIGHTEN Currency appreciation has helped the fight against import-fuelled domestic inflation, which has likely peaked and is set to ease as global commodity prices cool. All of which makes it easier for the central bank to keep a tight leash on the yuan, according to analysts familiar with Beijing's policy-making process.
China's Commerce Ministry urged the United States not to "politicise" economic issues on Wednesday and said that legislation aimed at pressing China to let the yuan rise faster violates international trade rules.
Premier Wen Jiabao said on Saturday the yuan would remain stable to protect exporters, state media reported. Wen said "a basically stable exchange rate" would help stabilise exports and enhance business confidence. There's some strong evidence that stabilisation is setting in, even if temporarily.
The yuan ended seven straight months of appreciation against the dollar last week after the US Senate passed a bill aiming to punish China for having an undervalued yuan. In the six trading days since the US bill was passed, the yuan has slipped 0.6 percent against the dollar from a record high of 6.3375 hit on October 11, a sizeable lurch for a currency that usually rises or falls no more than 1 percent in any month. "This should be seen as a reaction to the US bill," said Li Wei, an economist at a think-tank under China's commerce ministry.
INVESTORS EYE MODEST GAINS Even though analysts do not expect the bill to become law, investors are anticipating the pace of appreciation in the yuan to ease. The premium that China's benchmark one-year onshore forwards enjoy against spot yuan hit a six-month low on Friday as investors pared expectations for gains. Against the dollar, the yuan slipped 1.2 percent in September, its first decline since January.
"This could be temporary, once the external risks ease and China's growth stabilises, the yuan will climb up again," said Wei Yao, China economist at Societe Generale in Hong Kong. Indeed the yuan's inflation-adjusted value against a basket of currencies rose 3.8 percent in September, according to the Bank for International Settlements, suggesting that its steadying against the dollar is not a shift in overall currency policy.
Analysts point out that strong demand from Chinese firms and tight supply of greenbacks globally caused by Europe's debt crunch may also have exaggerated recent dollar/yuan moves. The latest Reuters poll, for instance, still forecasts a yuan gain of some 4.8 percent against the dollar this year. And while CCIEE's Wang expects the pace of appreciation to ease to 3-4 percent in 2012, that's hardly a complete halt.
Indeed, few analysts believe China will go as far as to repeg the yuan to the dollar after unshackling and revaluing it in a landmark move in July 2005, pointing to the near 30 percent gain since as evidence that China wants currency appreciation. But while investors might be twitchy in the near term, given the gloomy economic backdrop and rising political rhetoric, few are willing to bet against one of the clearest trends in global financial markets of the last six years that in real inflation adjusted terms has delivered a 40 percent rise in the yuan.
"The problem is not as serious as in 2008. Exports are slowing but not collapsing," said Gao Shanwen, chief economist at China Essence Securities in Beijing, adding that any pause would be "related to the US bill, but the overall trend of yuan appreciation remains intact." Indeed, the yuan's path higher has been peppered with pauses of varying length and intensity - often dictated by broad market conditions - but the overall policy of gradual appreciation has been one that investors have clearly heeded.