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Treasury & Capital Markets
China allows renminbi exchange flexibility
People’s Bank of China stresses that the decision is based on China’s strategic needs to shift to a domestic-driven economy and it will help to alleviate internal inflationary pressures
Amy Lam 21 Jun 2010
China’s unexpected announcement on currency reform over the weekend has promised renminbi flexibility but not a dramatic appreciation.
 
China will only allow a “gradual adjustment” of the renminbi exchange rate. The renminbi exchange rate regime will continue to reflect market supply and demand with reference to a basket of currencies, which was introduced on July 21 2005, according to a statement by the People’s Bank of China (PBOC).
 
Both economically and politically, China has been under strong pressure by the US and other members of the group of 20 major economies to revaluate its undervalued currency, which is cited as the cause of unemployment and trade deficit in the Western economies.
 
The decision to reform the renminbi will eventually boost the spending power of the Chinese consumer and ease tensions of global trade imbalances, paving the way to a rebalancing of the global economy.
 
Taking note of Japan’s experience in the 1980s, Chinese policy makers are being cautious and have not gone in for a drastic appreciation of the renminbi which may cause property bubbles in the country and lead to an overheated economy while thousands of export-driven manufacturers would face enormous difficulties.
 
In a separate statement, PBOC stresses that the decision is based on China’s strategic needs to shift to a domestic-driven economy and it will help to alleviate internal inflationary pressures. As a beneficiary of the globalized economy, China will continue to adopt win-win solutions to exchange reform that fit China’s strategic development and the international trade environment.
 
According to the renminbi exchange rate regime, the currency can trade within a band of positive or negative 0.5pc against its reference basket of currencies. The renminbi has gained 21pc against the US dollar since PBOC initiated the reform in 2005. But China pegged the renminbi to the greenback in 2008 during the global financial crisis.
 
Economists and analysts have mostly welcomed the announcement. Morgan Stanley says in a research note that PBOC’s announcement means China would exit the USD-peg and return to its pre-crisis arrangement trading band, which will be positive for Asian credit markets, and in particular for Chinese property credits and banks as less aggressive policy rate hikes and upside for loan growth quota is expected.
 
Even though it is a relatively small measure, the move is seen as another milestone towards the long-term trend to shift away from export-driven growth and toward consumption-led activity, according to a research by Macquarie.
 
Asian markets cheered China’s decision, with benchmark indexes including Japan’s Nikkei, Hong Kong’s Hang Seng and Hang Seng China Enterprises, Taiwan’s weighted average and Shanghai’s SSE Composite recording positive returns on Monday morning (June 21). For the Hong Kong market, the across-the-board jump on the ninth consecutive day’s surge is led by domestic play such as mainland financials, property and paper manufacturers that stand to benefit from the expected reduction of non-renminbi costs. 
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