China preparing to end dollar peg for yuan

By Garry White
The Telegraph, London
Saturday, March 6, 2010

http://www.telegraph.co.uk/finance/7386391/China-ready-to-end-dollar-peg...

The head of China’s central bank has given the strongest signal yet that the country will move away from pegging its currency to the dollar, but he said any changes would be gradual.

At the annual session of the legislative National People's Congress in Beijing, Zhou Xiaochuan, governor of the People's Bank of China, said that the days of the "special yuan" policy were numbered. He described the dollar peg as a "temporary" response to the global financial crisis but gave no timescale for any change in policy. The currency has been pegged at about 6.83 yuan per dollar since July 2008.

Many economists expect China to allow the yuan to appreciate slightly this year, but the cautious tone by Mr Zhou means that any change may not happen for some time. He said that the central bank would maintain the "basic stability" of the currency. So even though the Chinese economy grew by 10.7 percent in the fourth quarter of last year, the country's loose monetary policy looks set to continue.

"If we are to exit from irregular policies and return to ordinary economic policies, we must be extremely prudent about our timing," Mr Zhou said. "This also includes the [yuan] exchange rate policy."

China's currency policy has been subject of fierce debate, particularly in the US and Europe, with the country's central bank accused of keeping the yuan artificially low to promote a domestic exports boom. An artificially lower currency makes the country's goods and services more competitive, leaving other exporters at a disadvantage. Jim O'Neil, Goldman Sachs' chief economist, thinks the Chinese should allow their currency to appreciate by as much as 5 percent.

In recent weeks President Obama has been vocal on the issue of the artificially low currency. "China and its currency policies are impeding the rebalancing [of the global economy] that's necessary," Mr Obama told Bloomberg last month. "My goal over the course of the next year is for China to recognize that it is also in their interest to allow their currency to appreciate because, frankly, they have got a potentially overheating economy."

The relative value of the dollar is important to China, as the country is the world's largest holder of US government debt. According to data from the US Treasury Department, China held $894.8 billion of US Treasury securities at the end of December. Roughly two-thirds of the country's reserves are believed to be in dollars and dollar-denominated assets such as gold.

"The US dollar is still an extremely important currency, playing a key role in international trade, cross-border capital flows, and direct investment as well as in determining whether we can smoothly overcome the global financial crisis," Mr Zhou said.

When China eventually abandons the peg, the country will have to manage its exit strategy carefully. If the central bank allows a gradual appreciation of its currency, which would be the best strategy for its exporters, there could be an inflow of funds from speculators betting on further appreciation. However, a one-off revaluation could deal a severe blow to the country's manufacturing sector.

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