Surging Yuan May Signal Boost For Global Recovery

By Bloomberg News - Aug 12, 2011 5:46 AM GMT+0300

The yuan’s strongest gain in more than three years may herald a new stimulus for a flagging global recovery as Chinese importers get more firepower to buy up goods from slowing economies in the U.S. andEurope.

The currency has climbed 0.7 percent this week, more than any weekly increase since December 2007, breaking through 6.4 per dollar for the first time in 17 years. The yuan traded at 6.3953 as of 10:27 a.m. in Shanghai today.

Chinese officials are allowing the currency to appreciate as slowing growth and gyrations in global currencies and stock markets threaten to spark a new recession. Besides countering inflation and accelerating China’s shift to domestic-driven growth, a stronger yuan may also signal a willingness to help shore up slumping confidence in the global economy.

“They may want to be seen as stepping up to the plate as the second-largest economy,” said David Cohen, an economist at Action Economics in Singapore who formerly worked for the U.S. Federal Reserve. “Inflation is also a little higher than they would want.”

During the global financial crisis, Premier Wen Jiabao’s government halted the yuan’s gains for almost two years, keeping the currency pegged to the dollar until June 2010. It has strengthened more than 6 percent since then. Reasons for allowing gains now include elevated inflation and a surge in the trade surplus in July.

Global Response

Barclays Capital analyst Chang Jian estimates that the currency will rise 5 percent to 7 percent over a year. That would help to boost demand that is already surging, with imports climbing 27 percent to a record $973 billion in the first seven months of 2011, according to trade data released this week.

On Aug. 9, China’s State Council urged global cooperation to counter turmoil in financial markets and endorsed a Group of 20 pledge to take “all necessary initiatives in a coordinated way” to support financial stability and growth. While developed nations are struggling, the Chinese economy may expand more than 9 percent this year, according to the median estimate in a Bloomberg News survey of economists.

This week’s accelerated gains may partly be a “show of confidence” and “an effort to not appear overly worried about short-term financial market developments,” said Sacha Tihanyi, a Hong Kong-based currency strategist at Scotia Capital, the investment banking unit of Bank of Nova Scotia.

Biggest Jump

The yuan rose 0.37 percent to close at 6.3945 in Shanghai yesterday, its biggest jump in nine months, according to the China Foreign Exchange Trade System. It touched 6.3895, the strongest level since the country unified official and market exchange rates at the end of 1993.

Zhang Xiaoqiang, vice chairman of the National Development and Reform Commission, said that the currency will appreciate “gradually,” state radio reported yesterday evening.

A front-page commentary in the China Securities Journal today said that the government may rely more on strengthening the yuan to ease inflation pressures, with the central bank cautious on raising interest rates because of the risk of attracting capital inflows.

The currency remains undervalued by 3 percent to 23 percent, depending on methodology, International Monetary Fund economists said in a report released last month.

Key Driver

Inflation that reached a three-year high of 6.5 percent in July is driving the gains, said Arjuna Mahendran, who is the Asian head of investment strategy at HSBC Private Bank in Singaporeand helps manage about $499 billion. A side-effect is the boost to consumption as imports become cheaper for Chinese consumers, he said.

The IMF said last month that a stronger yuan would help to make the Chinese economy more stable by aiding a rebalancing of growth toward domestic demand and away from exports and investment. One aim is to limit the risk of any slump in Chinese growth that would reverberate through the global economy.

Wage increases and a stronger social safety net are also elements of a drive to boost consumption, laid out in a five- year plan running through 2015.

At Goldman Sachs Group Inc. in Hong Kong, economist Michael Buchanan said yesterday that China may allow yuan gains of about 6 percent a year to counter inflation, boost domestic demand and limit the accumulation of foreign-exchange reserves.

Cnooc Ltd., China’s biggest offshore energy explorer, said that a stronger yuan cuts costs for imported equipment and materials and also the company’s repayments of dollar- denominated debt. Currency gains also trim the value of gas and oil sales, said Jiang Yongzhi, a Beijing-based spokesman.

U.S. Monetary Easing

Chinese officials are concerned that more quantitative easing by the U.S. is looming and will add to inflation pressures.

The National Development and Reform Commission said this week that such measures are “highly likely” after U.S. lawmakers agreed to raise the debt ceiling in the world’s biggest economy, avoiding a default. This may push up commodity costs and “cause more hot money to flow into developing countries including China,” making it harder to control prices, the agency said.

Signs of waning demand including slumping overseas orders for Japanese machinery, reported by the Cabinet Office in Tokyo yesterday. Japan may cut its growth forecast for the year ending March to 0.5 percent from 1.5 percent, Kyodo News and the Nikkei said yesterday.

Economic ‘Headwinds’

In the U.S., the Federal Reserve has signaled that weakness in the economy may extend through mid-2013 by pledging to keep interest rates at a record low, while the Bank of England said this week that economic “headwinds” are intensifying.

The debt burdens of developed nations are limiting efforts to spur growth and investors are concerned that some European nations are at risk of default. The European Central Bank has restarted a bond-purchase program and extended it to include the debt of Italy and Spain.

This week’s gains by the yuan indicate that the Chinese government “is not yet convinced that there is going to be a double-dip or a new recession,” said Ding Shuang, a senior economist at Citigroup Inc. in Hong Kong, who formerly worked at the People’s Bank of China and the International Monetary Fund.

--Zheng Lifei in Beijing and Sophie Leung in Hong Kong. With assistance from Paul Panckhurst, Aibing Guo and Fion Li in Hong Kong, and Weiyi Lim in Singapore. Editors: Paul Panckhurst, Patrick Henry.

To contact Bloomberg News staff for this story: Zheng Lifei in Beijing at +86-10-6649-7560 orlzheng32@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net