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The Uncertain Future of the Yuan
Summary:

From Money & Investment, page 17, issue no. 370, June 2, 2008
Translated by Liu Peng
Original article
: [Chinese]

The gradual upward climb of the exchange rate of the Chinese yuan against the US dollar for the last three years appeared to have come to a slow since mid April.

Market watchers noted that despite a slight decline in the yuan's value of late, the possibility of devaluation was slim, as China's reserve surplus, international demand, and investors' optimism all continued to add pressure for the currency to appreciate.  

However, they believed the Chinese central bank might dish out exchange rate policies aimed at safeguarding the competitive edge of Chinese exports, such as to restrain the nominal effective exchange rate for the basket of currencies, thus maintaining exports to the Europe while keeping with the fluctuation of US dollar.

China started a floating exchange rate regime based on market demand with reference to a basket of currencies – including the euro and Japanese yen in July 2005. Since then, the yuan value has appreciated over 15% against the dollar.

Uncertainties in the Yuan's Valuation
On May 6, the central parity of the yuan to the dollar reached 6.9888. An analyst concluded then that: "Judging from the market trading, institutional investors have already accepted the fact that the exchange rate of yuan against dollar would hover around the fringes between six and seven."

However, on the same day, a market report penned by Tan Yaling, senior researcher at the Bank of China (BOC), said the rate of yuan appreciation had already exceeded China's capacity.

Tan's report said the Chinese government might consider a one-off devaluation of the yuan to counter the strong expectation from overseas for the yuan to appreciate.

Owing to BOC's status – a powerful state-owned bank, which is regarded as closely linked to official sources and traditionally engaged in foreign exchange affairs – the report by Tan was taken to heart by international investors, who interpreted that the Chinese government intended to excessively slowdown the yuan's appreciation. 

Such interpretations of the future valuation of the yuan transpired into market trading the next day, when the off-shore one-year yuan NDF (non-deliverable forward) declined to 6.5250 yuan, a drop of 850 basis points compared to 6.4400 in the previous day.

The drop was the biggest in a single day since October 2003. Meanwhile, Hong Kong Hang Seng Index also declined by 652 basis points.

The yuan NDF is a kind of financial derivative instrument that helps foreign companies in china or companies with transactions overseas to hedge their foreign-exchange risk.

The same day, the central parity of the yuan and dollar moved to 7.0005 while the yuan value in NDF slumped, as if the long-term futures for the yuan had lost its appeal.

On May 9, a BOC spokesman came forward to clarify that Tan's opinion didn't represent the stance of the Bank.

The same day, however, another researcher Mei Xinyu, who is regarded as closely associated to Chinese officials, penned an analysis reprinted in a local newspaper, saying the sharp decline in NDF indicated that a change in the investment and trade sentiment might led to a reversal in the yuan's appreciation. Mei is attached to the Chinese Commerce Ministry's International Trade and Economic Cooperation Research Centre.

Lowered Expectations
By May 12, China International Capital Corporation chief economist Ha Jiming noted that though the yuan had slowed its appreciation against the dollar, it was not a reversal trend and the yuan was expected to continue to rise in value.

Some investment institutions echoed Ha's opinion, such as the Standard Chartered Bank, which believed the slower pace in April was only a temporary interval.

The overseas market, however, appeared to take the opinion of Tan and Mei more seriously. On May 14, the off-shore yuan NDF reached 7.0128, which was 94 basis points higher than the ceiling price in the spot market.

It was the first time since 2006 that the yuan's value in futures market was lower than that in the spot market. It was also an indication that overseas investors expected yuan to depreciate in the near future.

The re-bound came only days later. On May 19, the central parity of yuan to dollar in the spot market gained from 6.98 the previous day to 6.9752. By May 30, the central parity value maintained around 6.94.

Despite the recovery, market watchers remained cautious. For instance, Morgan Stanley chief economist Stenphen Jen advised investors against over-investmenting in the yuan NDF.

Despite experiencing such a strong appreciation round, many researchers still held prudent attitudes towards the yuan's future. For instance, Stephen Jen, chief economist of Morgan Stanley, suggested the investors not buy over RMB NDF.

Meanwhile, JP Morgan Chase had readjusted its projection of the 2008 year-end exchange rate between yuan and dollar. Instead of the initial 6.30 yuan to one dollar, the expectation was lowered to 6.50 yuan to a dollar in anticipation of a slower pace of appreciation.


 

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