WORLD / Wall Street Journal Exclusive

Move to strengthen yuan may ripple across Asia
Updated: 2006-05-16 10:36

HONG KONG -- Beijing, in a move that ends weeks of stalling and should help President Bush contain complaints in the U.S. about China, gave the go-ahead for a stronger Chinese currency.

China's central bank allowed the yuan to briefly break through the symbolically important level of 8.0 to the dollar. The move came just days after the U.S. Treasury Department drew back from confrontation with China by determining that Beijing wasn't manipulating its exchange rate to artificially boost its exports.

The dollar has been falling against currencies around the globe in recent weeks, with quiet acquiescence from Washington, where concerns are mounting over the gaping U.S. trade deficit and the political fallout it entails. Monday, the dollar briefly fell below 110 yen, its lowest level in eight months, amid expectations that U.S. interest-rate increases are coming to an end just as Japan prepares to raise its rates. News on the yuan also spurred selling against the yen: Signs of a strengthening yuan tend to lift the yen due to Japan's proximity to China.

Washington has been pressing China and its neighbors to allow stronger currencies to help cut their huge trade surpluses with the U.S. by making their exports more expensive in dollar terms. Economists say Beijing's move might add momentum to currency appreciation around Asia that could help to unwind global economic imbalances.

Before the start of trading in Shanghai Monday, the Chinese central bank lowered its daily trading benchmark for the yuan to the point where one U.S. dollar fetched fewer than eight yuan, a psychologically important level that it had maintained as a barrier for weeks. By breaching that level, the bank sent a signal that it will allow the yuan to advance at a faster pace, traders and economists say.

Since authorities revalued the currency by 2.1% to 8.11 against the dollar in July, this is the first time the yuan has traded below 8.0 to the dollar. Since the revaluation, the yuan has climbed only an additional 1.3% for total appreciation of 3.4%, a considerably slower rate than the strengthening of other currencies around Asia.

China allows the yuan to rise or fall 0.3% each trading day against a midpoint benchmark. The "central parity" is announced by the central bank, and Monday it set that point at 7.9982 compared with 8.0082 on Friday. The highest level the yuan had reached previously was 8.0022.

However, the yuan didn't remain less than 8.0 to the dollar Monday. After touching a high of 7.9972, It closed at 8.0030 to the dollar. That compared with a closing level of 8.0061 last Friday.

"You will see a faster pace of appreciation" for the rest of the year, says Fan Jianjun, a financial analyst at the Development Research Center, a Chinese cabinet think tank.

The news about the yuan made Chinese stocks surge on hopes among domestic investors that a stronger currency will draw in more foreign-equity investors. The Shanghai Composite Index rose 3.8% to finish at its highest level in 25 months.

The Chinese move comes at a propitious moment for Mr. Bush's administration. U.S. Treasury Secretary John Snow is scheduled to testify tomorrow and Thursday before the House and Senate banking committees about his decision not to brand China a currency manipulator in the report on global currencies. Mr. Snow can point to the latest yuan appreciation as evidence his diplomacy with Beijing is working.

"Greater flexibility in China's exchange rate is a positive development both for China and for the global economy," Treasury spokesman Tony Fratto said in a written statement.

"When China reformed its currency regime in July 2005, it established a mechanism for greater daily fluctuations in relative currency values, and we encourage Chinese authorities to show more confidence in allowing this mechanism to work," he added. "However, it's important to note that there is no specific target for RMB/dollar currency values. Currency values are best set in open, competitive markets."

U.S. Senator Charles Schumer, a New York Democrat, co-author of a bill that would impose 27.5% tariffs on imports from China, issued a measured statement in response to the currency's appreciation. "The fact that the yuan finally dipped below 8 is good news, but only if it portends further movement," he said. "The Chinese government knows that reducing controls on the currency is very important to creating a level playing field in world trade."

Pressure on Beijing to allow a faster rate of appreciation hasn't all been coming from Washington. More important from Beijing's point of view, say many economists, is China's need for a stronger currency to tackle signs of economic overheating and prevent a crash. Booming exports have flooded the economy with cash and led to runaway bank lending and investment. A stronger yuan will help slow the export momentum.

Figures released Monday showed that broad money supply -- including cash in circulation and deposits in banks and brokerage firms -- rose 18.9% in April from a year earlier. This helped propel expansion in yuan loans during the month by 15.5% compared with the same month last year. Loan growth in March was 14.7%.

Adding to the incoming flood of cash, foreign direct investment in the first four months of this year totaled $18.48 billion, a rise of 5.8% from the same period last year, official data showed.

The immediate impetus for the yuan's advance through the 8.0 level was last week's U.S. Treasury decison not to label Beijing a currency manipulator. The yuan had been on track to appreciate 3% to 4% against the dollar before the momentum died in April as Beijing waited for that decision.

Many economists expect the yuan's rise to pick up pace from earlier this year. Jonathan Anderson, chief Asia economist for UBS, said he expects about 5% appreciation for the whole year.

The yen also strengthened Monday. In the late afternoon in Japan, the dollar was down 0.3% on the day at 109.71 yen, off the day's low of 109.35 and not far from an eight-month low of 109.29 hit on Friday. Monday's news on the yuan added to the market's yen-buying momentum, traders said.

The dollar has been falling against currencies around the world during recent weeks, a process that Washington is tacitly encouraging as a way to narrow its gaping trade gap.

In Asia, central bankers take their cue on exchange rates from the currencies of the region's two giants -- Japan and China. The yen has gained sharply against the dollar this year, pulling up currencies such as the Singapore dollar, the Korean won and the Indonesian rupiah.

Mr. Anderson says the yuan's resumed climb against the dollar "will serve as a further catalyst" to boost other currencies around the region. "To have all of Asia moving, including the yuan, is a big move collectively," he says.