2010-03-17

Yuan revaluation: not if, but when and how

I thought China would be taking much longer to revalue the currency, and they may still take longer than most foreign observers expect. However, as has been apparent from growing at cross border settlements in yuan, the Chinese are serious about reforming the currency.
China Leans Toward Yuan Float
Some economists say that, from a purely market-oriented perspective, there is actually no way to gauge whether the yuan should appreciate or depreciate. They recommend a fixed policy, rather than blind action, when facing uncertainty. If exchange rate reforms raise expectations for further increases in the yuan's value, the flow of hot money into China will drastically increase, they say, creating a liquidity overflow and possibly an asset bubble, and reenact the scene after exchange rate reforms in 2005.

Nonetheless, some argue exchange rate reforms should be implemented sooner rather than later. In spite of international pressure, and even though further exchange rate reforms again point to an appreciation of the yuan, there are still inherent advantages to reform.
The biggest, as Andy Xie pointed out, is the political benefit in terms of international relations.
Ha recommends letting the yuan appreciate based on a basket of currencies. A similar view is also shared by Ding Zhijie, dean of the School of Banking and Finance at the University of International Business and Economics, who has called for the "de-dollarization" of the yuan.

Ding recommends assigning currency weights based on the proportion of export-import trade volume on a monetary basis from each country represented in the basket to China's total trade volume. The basket should include 18 currencies, he said, with the euro weighted at 17.91 percent, U.S. dollar at 14.68 percent and other currencies making up 56.15 percent of the weighted volume. "This is very important for promoting stable trade," he said.

The source close to the central bank said authorities should determine the weighted proportion for the basket of currencies by first considering the proportion that the currency holds in regard to trade settlements. Currently, more than 70 percent of China's cross-border trade settlements are in U.S. dollars, while the remaining 30 percent use other currencies such as the euro and pound. Second, most of China's US$ 400 billion in foreign debt is in U.S. dollars and "borrowing money to repay money" would require holding a certain amount of dollars. Market fluctuations also would require corresponding adjustments.

Opinions vary over whether individual currencies and their respective weights in a basket should be disclosed. Lu and Huang advocate copying Singapore's exchange rate system because authorities do not disclose currencies or their weights, and yet the system allows adjustments of individual weights based on conditions.

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