Yuan Appreciation

Yuan Change In one of the most anticipated changes of a currency regime in years, China on Thursday said it would end a decade-old fixed exchange-rate peg between its yuan and the U.S. dollar and target a basket of world currencies instead. China's mini-revaluation of its yuan currency, by itself, is unlikely to cut Beijing's trade surpluses or correct global economic imbalances. Even so, policy-makers and economists reckon it's a start.The shift comes three months after the Group of Seven economic powers called for "vigorous" action to correct world economic imbalances -- code for the ballooning U.S. current account deficit of some 6 percent of U.S. national income.The move, which will involve a small initial rise against the dollar of 2.1 percent, is far smaller than calls in the United States for a revaluation of 20 percent or more.But fingers were crossed that the more flexible basket system may mean incremental yuan appreciation will become easier to engineer, while avoiding any pounding of China's economy, now a critical engine of the global economy. Shortly after China's move, Malaysia also said it would drop a seven-year fixed exchange rate peg to the dollar. Speculation that South Korea, Indonesia and others allow their currencies to rise will help bring the dollar lower against Asia currencies in general, economists say.China is the third-largest trading partner of the United States and its sixth-biggest export market. But while it accounts for 12 percent of U.S. imports, Pacific Rim countries as a whole are the origin of a full third of U.S. imports.The 2.1 percent initial yuan rise will barely scratch China's manufacturing competitiveness. Average manufacturing wages in China, for example, are about $1 a day compared with $16 an hour in the United States. And more than 70 percent of Chinese exports to the U.S. are made up from imports from other Asian countries.THE ONLY POSITIVE ECONOMIC IMPACT OF THE INITIAL MOVE MAY BE TO DEFUSE INTERNATIONAL TRADE TENSIONS.That would be a relief to many investors, corporate planners and economists who feared a tit-for-tat trade war with the United States over the issue.

(Source : Reuters website)

Contribution by:
Akshay Sureka
IR 2005-07