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Asia: Currency traders expect China to revalue yuan

CORPORATE FINANCING NEWS

FOREIGN EXCHANGE

Participants in the foreign exchange market have caught a whiff of possible changes afoot in China's tightly controlled currency regime.

For the first time in many years, long-term forward currency contracts are pricing in a gradual rise in the value of the yuan, which is pegged at a rate of 8.28 to the US dollar.

Currency analysts at major banks forecast that the yuan will strengthen against the dollar in the year ahead, as the Chinese government edges nervously closer to a more-- open exchange-rate system in which the yuan's value would be allowed to fluctuate within limits.

Analysts at Deutsche Bank, for example, forecast that the yuan will rise to 8.15 to the dollar within the next 12 months.

"The yuan's transformation to a major traded currency will be one of the key exchange market trends of the next five years," says Anne Parker Mills, director of foreign exchange research at Brown Brothers Harriman in New York.

A surge in China's exports and a plunge in the trade-weighted value of the yuan are spurring talk that the Chinese currency needs to be revalued, Mills says. The debate is getting louder, especially in Tokyo, but the case for revaluation is not compelling, she says.

China's exports hit $326 billion in 2002, almost tripling in eight years and enabling the country to increase its foreign exchange reserves by $74 billion in 12 months. But China's trade surplus in 2002 was still below its 1998 peak, according to Mills. What's more, she says, China's rising share of world exports is largely due to increased trade specialization, from which many countries, especially Asian nations, benefit. About one-half of China's exports are produced by companies in which foreigners are owners. Since much of the cost of goods assembled in China is incurred elsewhere, a revaluation would not have much effect on their competitiveness.

It would be very risky for China to revalue the yuan, Mills says, because of potential capital flight. And for the United States, she adds, China's commitment to a fixed exchange rate is becoming critical to the financing of the US current-account deficit.

China has become the second-largest target for foreign direct investment after the United States and the second-largest holder of foreign-exchange reserves.

"A stable rather than a stronger yuan is in the best interest of the United States as well as China," Mills says. Recent talk of revaluation is an abrupt change from just a few years ago, she says, when everyone was speculating about a devaluation of the yuan.A few years before that, almost no one talked about the yuan at all, she adds.

The continuing strength of China's balance of payments and the country's relatively closed economy mean that China should not have to worry about any pressures to devalue in the foreseeable future, according to analysts at Deutsche Bank. Meanwhile, deflation and a political focus on stability also imply little inclination for China to revalue, they add.

The market is taking the risk of a revaluation of the yuan seriously, however. Non-deliverable forward contracts now price in gains in the yuan of 2% over the next year.

Copyright Global Finance Media Inc. Mar 2003
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