Yuan reform signals bullish outlook

Prior to the G20 summit in Toronto later this week, China's central bank said it will restart the reform of the yuan exchange rate regime, with reference to a basket of currencies.

In other words, Beijing will end the yuan's special peg to the US dollar since the start of the global financial crisis.

The People's Bank of China statement says this will enhance exchange rate flexibility. This could also mean the yuan may weaken against the greenback if other basket currencies such as the euro drops in value, but the more general expectation is for the yuan to strengthen.

As I've said before, the yuan will be a safe bet. The only question is how much the revaluation is going to be.

US President Barack Obama and Treasury Secretary Timothy Geithner were excited over the Chinese announcement - so much so the central bank had to issue another statement yesterday to dampen expectations before they soared too high. The PBOC insisted it will keep the yuan stable and balanced, ruling out a one-off revaluation.

So, will there be immediate appreciation? While the follow-up statement seems to suggest otherwise, a minor appreciation - say 1 percent - ahead of the G20 shouldn't be ruled out. There is a political need behind the move for both China and the United States.

In Washington, US lawmakers are threatening to take matters into their own hands and pass legislation to tax Chinese imports if the yuan doesn't appreciate. It's a matter of fact - or fate - that yuan valuation has always been a sensitive issue in US-China relations. For Obama and other US politicians, it will be in their interests to press for the yuan to rise because this would stimulate Chinese demand for US products, thus creating more jobs for Americans. This is a pressing issue for anyone looking for a second term in the White House.

But it is unlikely that Beijing will go as far as Washington wishes. Chinese leaders are also under pressure at home not to raise the yuan's value because it will hit exports particularly hard. Will they allow the yuan to rise 3 percent or more against the US dollar by year-end, as some punters predict? It all hinges on the global economic situation.

You may recall that when Geithner unexpectedly changed his Asian tour itinerary to include a brief stop in Beijing to chat with Vice Premier Wang Qishan in April, expectations were high that China was about to replace its dollar peg with the regime using a basket of currencies. But it didn't. Why?

The European national debt crisis was to blame. Because of the credit crisis facing the "PIIGS" countries, governments around the world have to postpone the timetable of their market exit strategies. Had it not been for the new European credit crisis, China may have relaunched the exchange rate regime reform two months ago.

That China thinks now is the right time to end the dollar peg, and to use a currency basket as the reference for the yuan, may also signal its leaders are now more confident about the economic outlook - both domestically and globally. Will Obama offer anything in return at the G20 summit? This is something to watch out for.

英文虎報 Central Station | By Mary Ma