Regional currencies to rise on China factor

By CECILIA KOK  cecilia_kok@thestar.com.my

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SPECULATION about China's intention to allow its currency to appreciate soon has been strengthened after an official paper over the week said the Chinese government would let the yuan, or sometimes called the renminbi, rise about 5% against the US dollar this year.

That's about two-percentage point higher than the expectations of most investors, who thought the maximum that the Chinese government would allow this year would just be an appreciation of 3% in the value of the yuan against the US dollar.

Needless to say, any appreciation of the yuan would certainly be welcomed by Western powers, especially the US government, which has long blamed China's currency policy of keeping its exchange rate significantly undervalued against the others as the main cause of global imbalances.

Western powers claim that China's significantly undervalued currency has given the country unfair trade advantage, and they point to China's ability to continuously enjoy huge trade surpluses over the years, while leaving the West with continuously huge trade deficits, as support of their claim.

Economists at Washington-based Peterson Institute for International Economics say their recent calculation show that the yuan remains 17%-20% undervalued against the US dollar to this day. That, the institute claims, is a deliberate manipulation to gain export competitiveness.

So, given the perceived significant undervaluation of the yuan, many economists do not think that the (probable) 5% rise in the yuan's value would be enough to appease the Western governments. Market observers believe China will remain under tremendous international pressure to let its currency rise faster to help in the global-rebalancing effort.

But to be fair, China has indeed made an effort to reform its currency policy the only thing is that it is doing it gradually. This is to maintain stability in its own financial and economic system.

Inflation management tool
In June last year, the Chinese government removed the two-year peg of the yuan to the US dollar, which had stayed at around 6.83 per US dollar since July 2008, to allow its currency to appreciate.

The removal of the yuan peg resulted in the yuan gaining about 3.33% against the US dollar as at the end of 2010. Nevertheless, the yuan was still an under-performer last year compared with other currencies in the region (as shown in the chart).

According to the China Securities Journal, a leading voice on the country's economic affairs, the Chinese government would most likely allow the intended rise of the yuan to be accelerated in the first half of this year. This comes as the Chinese government concedes to the use of currency as a tool to manage its fast-rising inflation.

China faces mounting inflation pressures after its November consumer price index (CPI) soared to a new 28-month high at 5.1%, and some economists had warned that if no urgent measures were implemented, the country's CPI could grow by 7%-8% over the next two months.

Economists say that by allowing its yuan to appreciate, China can alleviate the inflationary pressure as its imports of goods and services will naturally become cheaper. A higher value of its currency can also help reduce the impact of rising global commodity prices, especially that of crude oil and crude palm oil, on its domestic economy.

Regional currencies to advance
Besides the urgent need to curb rising inflation pressure, many believe that China President Hu Jintao's upcoming visit to the United States in the middle of this month, will also lead to the yuan rising faster in the first half of this year.

And with growing expectations of the yuan's appreciation in the near term, economists say regional currencies, including that of Malaysia, will likely gain further momentum, particularly in the early part of this year. Regional currencies tend to move in tandem with the changes in China's yuan, as the latter is often regarded as the “anchor” currency of the region.

Last year, the China factor had also played a role in lifting regional currencies, as wide expectations of a yuan revaluation then attracted many investors to put their bets on Asia-Pacific. Of course, the region was also attractive to investors because of its growth prospects and wide interest rate differentials with major developed economies.

And as foreign capital poured into the region, Malaysia's ringgit turned out to be the top-performing currency last year, having appreciated from 3.424 against the US dollar from the beginning of 2010 to 3.0635 against the US dollar at the end the year.

(As at the time of writing yesterday, the ringgit was quoted at 3.0698 to the US dollar.)

Based on local economists' report so far, the ringgit is expected to strengthen further in 2011, but only marginally, as policymakers are expected to intervene to minimise its rise. Economists believe the ringgit would end the year trading within the band of 3.00-3.05 to the US dollar.

They also believe that the strengthening of other regional currencies will also be somewhat curtailed, as Asian policymakers become increasingly concerned over the impact of the rise of their currencies on export competitiveness.

On the back of all these recent developments, it will be interesting to see how Asian governments adapt their currency policies this year to balance between the need of maintaining export competitiveness to support economic growth and boosting their purchasing power by allowing the currencies to rise, and hence, promote domestic demand.