Beijing Considers Plan To Move Its Currency Further From Dollar

Beijing Considers Plan To Move Its Currency Further From Dollar, Wall Street Journal
July 23, 2010

BEIJING—China will consider publishing an effective exchange rate for the yuan against a range of other currencies in an effort to de-emphasize its value against the dollar, in a further indication of how Beijing plans to manage the yuan since effectively decoupling it from the U.S. currency.

People’s Bank of China Vice Gov. Hu Xiaolian said in comments published on the central bank’s website Thursday that China will consider gradually moving toward using the effective exchange rate as a reference point for the yuan. The effective exchange rate is an estimation of the value of a currency relative to a group of other currencies, weighted based on the amount of trade between the countries.

If China were to adjust the value of the yuan based on its effective exchange rate, it could mean less focus on the bilateral yuan-dollar rate. However, the comments didn’t name currencies or offer additional details about how such a basket would work.

The statement marks the second time Ms. Hu has commented on the yuan’s exchange rate since China effectively ended the yuan’s peg to the dollar on June 19. The PBOC hinted then that it was moving to a new currency regime that would focus more on guiding the yuan against a basket of currencies.

The peg helped keep the yuan’s value stable in comparison to the dollar, reducing currency volatility as Beijing looked to foster the country’s torrid growth rate. But U.S. lawmakers, leaders from competing countries and others argued that the peg gave China an unfair advantage by keeping prices of its exports low.

Economists cautioned against reading too much into the statement, saying ambiguities remain in China’s stance, even if it is becoming clearer that a basket-based system is the long term goal for exchange rate policy. China’s central bank isn’t independent, and decisions on monetary policy and the exchange rate require the approval of the country’s top political leadership.

“The PBOC has always had these kinds of views, but they don’t have the power to make these kinds of decisions,” said Goldman Sachs economist Yu Song.

Also Thursday, Chinese Premier Wen Jiabao said policy stability will be the basis of the government’s economic work in the second half and that Beijing aims to maintain steady and fast economic growth in the long run. Mr. Wen’s comments suggest the government is placing slightly more emphasis on maintaining fast economic growth than it did in the first half, after China’s gross domestic product growth slowed to 10.3% in the second quarter from 11.9% in the previous quarter as stimulus spending continued to wind down gradually and controls on bank lending and property speculation began to be felt in the broader economy.

A strict linking of the yuan to a basket of currencies is unlikely in the near term, analysts say, as it would mean the yuan could fall against the dollar when the U.S. greenback is rising against other currencies, which could enrage parties in the U.S. calling for yuan appreciation.

Standard Chartered economist Stephen Green said the statement appeared to be part of an “education campaign” on the importance of the effective exchange rate. “But they haven’t said what’s in the basket, and they aren’t claiming to be linking to a basket, they are just telling us that they are referencing one,” he said.

China said it would reference a basket of currencies when it first unshackled the yuan from the dollar in July 2005. But it went on to allow a steady appreciation against the dollar for around three years, with no apparent reference to a basket. China resumed pegging the yuan to the dollar in 2008, in the midst of the global financial crisis.

In her statement Thursday, Ms. Hu said China’s intention has been to reference a basket since its initial exchange rate reform in 2005, “but the idea of only focusing on the yuan-dollar exchange rate is hard to change in the near term,” due to long-established habits, accounting practices, and other issues.

Ms. Hu said China may attempt to periodically announce estimates of the yuan’s nominal effective exchange rate, “to guide the public to change the habit of mainly focusing on the bilateral exchange rate with the dollar.”

The Bank of International Settlements publishes monthly estimates of the effective exchange rates of various countries. A key factor in determining the rates is deciding what weighting to give individual currencies, which BIS sets according to levels of trade in manufactured goods.

Ms. Hu said China’s weighting calculation will be mainly based on current account payments, but also take into account capital account payments and the currency composition of cross-border capital flows, among other factors.

Ms. Hu also said other factors will be considered in determining the yuan’s exchange rate, including jobs and the potential for large-scale company closures. The exchange rate will be based on economic conditions and the international balance of payments to avoid fluctuations in international and domestic markets, and speculation in financial markets, she said.

Any adjustment of the exchange rate should take into account the global economic situation, Ms. Hu said. Big trade surpluses posted after the exchange rate is adjusted would show that companies can tolerate the exchange rate change, but if there is a rapid decline, it would mean companies need to increase their capability of adapting to changes in the yuan’s exchange rate, she said.

—Aaron Back, Liu Li and Victoria Ruan