Currency Traders Expect China To Revalue Yuan
ASIA
Participants in the foreign exchange market have caught a whiff of possible changes afoot in China’s tightly controlled currency regime.
For the first time in many years, long-term forward currency contracts are pricing in a gradual rise in the value of the yuan, which is pegged at a rate of 8.28 to the US dollar.
Currency analysts at major banks forecast that the yuan will strengthen against the dollar in the year ahead, as the Chinese government edges nervously closer to a m
oreopen exchange-rate system in which the yuan’s value would be allowed to fluctuate within limits.
Analysts at Deutsche Bank, for example, forecast that the yuan will rise to 8.15 to the dollar within the next 12 months.
“The yuan’s transformation to a major traded currency will be one of the key exchange market trends of the next five years,” says Anne Parker Mills, director of foreign exchange research at Brown Brothers Harriman in New York.
A surge in China’s exports and a plunge in the trade-weighted value of the yuan are spurring talk that the Chinese currency needs to be revalued, Mills says.The debate is getting louder, especially in Tokyo, but the case for revaluation is not compelling, she says.
China’s exports hit $326 billion in 2002, almost tripling in eight years and enabling the country to increase its foreign exchange reserves by $74 billion in 12 months. But China’s trade surplus in 2002 was still below its 1998 peak, according to Mills.What’s more, she says, China’s rising share of world exports is largely due to increased trade specialization, from which many countries, especially Asian nations, benefit. About one-half of China’s exports are produced by companies in which foreigners are owners. Since much of the cost of goods assembled in China is incurred elsewhere, a revaluation would not have much effect on their competitiveness.
It would be very risky for China to revalue the yuan, Mills says, because of potential capital flight. And for the United States, she adds, China’s commitment to a fixed exchange rate is becoming critical to the financing of the US current-account deficit.
China has become the second-largest target for foreign direct investment after the United States and the second-largest holder of foreign-exchange reserves.
“A stable rather than a stronger yuan is in the best interest of the United States as well as China,” Mills says. Recent talk of revaluation is an abrupt change from just a few years ago, she says, when everyone was speculating about a devaluation of the yuan.A few years before that, almost no one talked about the yuan at all, she adds.
The continuing strength of China’s balance of payments and the country’s relatively closed economy mean that China should not have to worry about any pressures to devalue in the foreseeable future, according to analysts at Deutsche Bank. Meanwhile, deflation and a political focus on stability also imply little inclination for China to revalue, they add.
The market is taking the risk of a revaluation of the yuan seriously, however. Non-deliverable forward contracts now price in gains in the yuan of 2% over the next year.
THE AMERICAS
Dollar’s Role Secure As Reserve Asset
Plans by Russia and Central and Eastern European central banks to boost their non-do
llar reserves do not threaten the future of the dollar as a reserve asset, analysts say.
“The dollar is on one side of 90% of all trades in the spot and forward foreign exchange markets,” says Marc Chandler, chief currency strategist at HSBC Bank USA in New York.
“Central banks continue to rely heavily on the dollar as a reserve asset, and its role as such has increased—despite the large current-account deficit and the growing indebtedness of the United States,” Chandler says.
According to the International Monetary Fund, the US dollar accounted for 50% of reserves of industrial countries in 1990. By 2001 the dollar’s share had increased to 75%.
The Federal Rese
rve acts as a custodian for many foreign central banks, Chandler notes. The Fed’s custody account rose by $150 billion in 2002.
However, one reason the euro is rising is because small central banks around the world are adjusting their reserve positions to more accurately reflect their trade figures, according to Dennis Gartman, editor and publisher of the Virginiabased Gartman Letter.
The Romanian central bank, for one, announced recently that it would switch to the euro from the dollar as its reference currency beginning in March 2003 “to better reflect the weight of the eurozone in its foreign trade.” It is only logical that others will follow suit, Gartman says.
At the same time, however, Asian central banks are continuing to accumulate massive dollar reserv
es. In January alone, Japan’s official reserves rose by $8.9 billion, Taiwan’s reserves rose $3.1 billion, Singapore’s reserves gained $2.9 billion, Hong Kong’s rose $3.7 billion, and China’s were expected to show a rise of about $10 billion.
Venezuela Imposes Currency Controls
After closing its currency markets in late January in a desperate attempt to staunch capital flight, Venezuela re-pegged the bolivar at 1,598 to the US dollar and imposed rigorous foreign-exchange controls.
The controls will cause trade to suffer, which is what happened the last time controls were imposed, from 1994 to 1996, says Clyde Wardle, emerging-market currency strategist at HSBC Bank USA in New York.The restrictions also will do little to inspire foreign d
irect investment once the political climate has cleared,Wardle says.
“In addition, with President Hugo Chavez threatening to use the currency restrictions to punish his political enemies, importing businesses that supported the recent strike may be denied access to US dollars,”Wardle says.
However, the new capital controls mean the central bank does not need to spend its reserves or keep interest rates at levels that are restrictive to growth in order to defend the currency, he says.And at 1,598 to the dollar, the bolivar has lost 53% of its value of a year ago and should not be faced with quite the same selling pressure, he adds.
As long as Venezuela is pumping oil, it should be able to comfortably service its sovereign debt, Wardle says.
EUROPE
Euro Keeps Rising In Face of Bad News
German economic data have been extraordinarily weak of late, while the US economy has shown some signs of improvement, yet the euro has remained strong.What is going on in the currency market?
“Relative growth rates between Europe and the United States are no longer the story,” says Michael Rosenberg, head of global foreign exchange research at Deutsche Bank in New York.“The widening US current-account deficit and low US interest rates are driving the market,” he says.
The euro remains in a bullish trend on a medium-term basis, although it will pause occasionally to
consolidate its gains, according to Rosenberg.
“European rates have moved down relative to US rates, yet the euro remains firm,” he says. European rates would have to fall further before the dollar would be attractive, he adds.
With the US currentaccount deficit heading toward 6% of gross domestic product this year, the euro will continue to outperform the dollar, Rosenberg predicts.
Gordon Platt
