Low expectations should make China do more on yuan

January 11, 2011

By Wei Gu

The following article is part of Reuters Breakingviews’ e-book, Predictions for 2011. The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

HONG KONG — The Chinese currency rose just 3.6 percent in 2010. As political pressure ebbs and euro zone trouble spreads, traders now expect an even smaller gain for 2011. Beijing has said it wants to make the yuan more flexible. If it really means that, low expectations create a window of opportunity.

The People’s Bank of China managed to hold the yuan tight even in a year of high political pressure. Despite stern rhetoric from U.S. politicians ahead of mid-term elections and two G20 meetings, the currency strengthened 2.8 percent on a trade-weighted basis as at the end of November 2010. By contrast, the yen, Thai baht and Malaysian ringgit each rose 11 percent against the dollar in 2010.

Less external pressure for Beijing in 2011 may lead to complacency. The threat of U.S. trade tariffs and G20 pressure both produced small upticks in the yuan. But the U.S. Treasury has delayed the currency report that might label China as a currency manipulator. The Senate and Congress failed to pass punitive bills on Chinese trade before mid-term elections. As for pressure from G20, France, the host in 2011, has been encouraging China to style the yuan as a reserve currency, so may be less inclined to complain about the exchange rate.

Besides, China’s authorities have other things on their minds. China’s next leadership reshuffle is scheduled to take place in late 2012. The debt crisis in the European Union, China’s biggest export buyer, has not been resolved. Chinese exports fell 6 percent in the month of October. These things help explain why non-deliverable yuan forwards are pricing in just 2.3 percent appreciation, around the lowest level in a year.

But this might in fact be the best chance for China to make changes to the yuan for its own good. Beijing could strengthen the currency more without appearing to reward speculators, or cave in to foreign pressure.

There are two reasons why it should do this. First, the cost of keeping the yuan cheap is rising. The central bank injected $78 billion of liquidity, the largest amount in two years, into the domestic system in October alone through buying foreign currency from its banks. A stronger yuan may also alleviate some imported inflation — input prices have risen every month since July, according to the official Purchasing Managers’ Index.

In the long term, a more expensive yuan should make Chinese people feel richer, and consume more. Policymakers consistently say that is what they want to happen. Besides, the decision-makers in Beijing seem to like surprises, as October’s sudden late-night interest rate hike showed. Revaluing in 2011, when few expect it, could be just their style.

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