China's yuan may resume rise against dollar ... gradually

Sept. 18, 2009, 6:19 a.m. EDT

China's yuan may resume rise against dollar ... gradually
By Chris Oliver, MarketWatch

[link to www.marketwatch.com]

HONG KONG (MarketWatch) -- Chinese authorities may be about to loosen the reins on the nation's currency, allowing appreciation against the U.S. dollar to resume, although the pace could be slower than it was before the financial crisis.

"We are not looking for any abrupt moves, but directionally it would be for a stronger yuan and a weaker dollar," said Mitul Kotecha, head of global foreign-exchange strategy at Credit Agricole's Calyon.

On Friday, the yuan edged lower as businesses shut early in Beijing as the capital prepares for the final rehearsal of National Day celebrations. The yuan ended at 6.8282 against the dollar in over-the-counter trade in Shanghai, down from Wednesday's 3 1/2-month closing high of 6.8260 to the dollar, according to Dow Jones Newswires.

Calyon forecasts the Chinese currency will strengthen, with the greenback falling to 6.22 yuan by the end of 2011. The bank estimates the Chinese currency is about 15% to 20% undervalued at present levels.

Still, the pre-crisis pace of appreciation for the Chinese unit, which gained about 5% a year on the dollar earlier this decade, is unlikely to be repeated, with Beijing turning to a slower rise for its currency.

"What the authorities want to avoid is any instability," Kotecha added. "It's difficult to see a very rapid appreciation from the current level."

To be sure, the Chinese yuan -- also known as the renminbi or "people's currency" -- has been something of sleeper over the past year, remaining almost unchanged since July 2008.

Beijing abolished the yuan's peg to the dollar in 2005, and it now allows the currency to fluctuate up to 0.5% from a so-called "central parity rate," which the People's Bank of China sets daily.

Since the revamp, which included a one-off revaluation of 2%, the yuan has appreciated about 21% against the dollar.

"The yuan is stuck in domestic and international politics," said Bank of America Merrill Lynch economist Ting Lu, referring to domestic pressure from exporters to devalue and international pressure to keep a stable appreciation.

He added the yuan will likely be allowed to creep higher once China's export sector begins to grow again, something which could be seen by the end of this year.

Like Calyon, Merrill Lynch says the yuan is undervalued but adds that it's hard to say by how much.

Appreciation pressure returning
During the height of the financial crisis, China resisted the temptation to devalue the yuan on apparent concerns such a move would spark a round of competitive currency devaluations among its regional neighbors.

In December 2008, for instance, Merrill estimates markets were pricing in a 10% deviation in the Chinese currency.

As the crisis eased, Chinese authorities decided to keep the currency basically flat against the U.S. dollar, which Lu said was an attempt to discourage foreign capital inflows.

But now pressure for the currency to appreciate is returning, Lu said, adding that China has maintained a monthly trade surplus of about $10 billion throughout the crisis.

Calyon's Kotecha says China will eventually revert back to its 5% annual appreciation against the U.S. dollar, although exactly when it will ease off the brakes is difficult to anticipate.

"China will look at other central banks at a time when the yuan has lost some competitiveness and be very uneasy about allowing further appreciation when other central banks in Asia are still holding their currencies at relatively weaker levels than they should be," Kotecha said