China may revalue sooner rather than later

We already mentioned this a couple of days ago. Very positive for everybody, especially holders of companies that thrive in the domestic Chinese market, like China Fire (CFSG) and Fuqi International (FUQI)..

China Gives Signs It May Allow Yuan Appreciation
Monday, 08 Mar 2010 09:09 AM

China faces mounting pressure from trading partners to loosen currency controls and is giving signs it might raise the value of the yuan to ease strains on its fast-growing economy.

A stronger yuan could help China’s leaders achieve their goal of making the economy more self-sustaining by boosting consumer buying power and reducing dependence on exports and investment.

It could narrow China’s politically volatile trade surplus, making the flood of foreign money pouring into the economy more manageable.

A change might also help defuse tensions with the United States, Europe and other trading partners that complain an undervalued yuan makes China’s exports unfairly cheap and hurts foreign competitors, possibly prolonging the global economic crisis. Some American lawmakers are calling for punitive tariffs on Chinese goods if Beijing fails to act.

Analysts say Beijing might allow the yuan to rise against the dollar before the middle of this year. But they say any increase will be gradual and do little to narrow U.S. and European trade deficits and create jobs.

“Even if China starts to appreciate, the possibility is it will be very slow and gradual, without an immediate impact on trade,” said Nicholas Consonery, an analyst in Washington for Eurasia Group, a consulting firm.

On Friday, Premier Wen Jiabao said in a speech to China’s legislature that the yuan will be kept “basically stable” at an “appropriate and balanced” level this year, though he gave no explanation of what that would mean.

Beijing tied the yuan to the dollar for decades but broke that link in 2005 and allowed it to rise by about 20 percent through late 2008. The government slammed on the brakes after the crisis hit and has held its currency steady against the greenback to help exporters compete as a plunge in global demand wiped out millions of Chinese factory jobs.

The United States and Europe downplayed currency complaints as they worked together with Beijing to revive global growth. But facing pressure to create jobs, they and governments as farflung as Brazil have renewed demands for China to act.

President Barack Obama vowed in early February to “get much tougher” in trade disputes with China and to press for an end to currency regimes that he said depress export prices and put U.S. companies at a disadvantage. The U.S. Treasury has the option of declaring Beijing a currency manipulator in a report due out in April, which could set the stage for a complaint to the World Trade Organization and possible sanctions on Chinese goods.

Last year’s U.S. trade deficit with China was $227 billion, down 15 percent from 2008 but among the highest ever. The 27-nation European Union reported a 65 billion euro ($88 billion) deficit with China for the first half of 2009.

A bipartisan group of 15 American senators urged Commerce Secretary Gary Locke in a Feb. 25 letter to investigate whether Beijing improperly helps Chinese companies by holding down the yuan. They said it is undervalued by up to 40 percent.

A stronger yuan would help Beijing get back on track to boosting household spending power after its 4 trillion yuan ($586 billion) stimulus package helped China to rebound quickly from the global crisis but worsened the tilt toward relying on investment to create jobs.

Chinese leaders worry that reckless overspending on unneeded factories and other assets could lead to financial problems, while the country can no longer count on double-digit annual export gains to drive growth.

But they face a daunting potential pitfall: A stronger yuan might hurt exports and cost jobs, fueling social tensions, while spending by China’s consumers might not rise fast enough to fill the gap.

“They are in a difficult balancing act,” said Michael Pettis, an associate professor of finance at Peking University’s Guanghua School of Management. “The steps that need to be taken to rebalance the economy worsen the unemployment problem, and the steps that are taken to resolve unemployment worsen the imbalance.”

Analysts say a rise in the yuan could begin before the middle of this year if export growth, which revived in December, stays on track.

That might coincide with the June meeting of the U.S.-China Strategic and Economic Dialogue, where the Americans are expected to make currency a priority. It would let Beijing’s envoys respond to U.S. complaints by saying it was already taking action.

In a signal Beijing might be about to act, President Hu Jintao used the term “speed up” 50 times in a Feb. 3 speech to refer to building a consumption-based economy.

“There is an urgency about this. They realize this investment- and export-based economy needs to be balanced,” said Citigroup economist Ken Peng.

But currency policy changes aren’t expected during the two-week annual meeting of China’s ceremonial legislature that ends in mid-March — a high-profile event when communist leaders try to prevent any shocks to business.

Analysts say a likely scenario is a small one-time rise in the yuan’s value against the dollar, followed by a gradual, long-term increase to allow exporters of shoes, toys and other low-profit goods to adapt to tougher conditions.

China took a similar approach in 2005, when it revalued the yuan by 2 percent in a single day, then allowed a gradual, tightly controlled upward crawl that saw it gain about 5 percent annually.

“It’s impossible for them to revalue in a sharp one-off move,” Peng said. “If you do a one-time adjustment of 5 percent, that will put a lot of businesses into the red instantly. so that’s not something they are willing to do.”

In a possible effort to prepare the public for a change, government researchers have been quoted in the state press discussing possible approaches to a revaluation. A commentary in the China Securities Journal newspaper by Zhang Ming, a finance specialist at the Chinese Academy of Social Sciences, said the yuan might be allowed to rise by 5 percent this year.

Yet even if Chinese goods get more expensive in dollar terms, that won’t drive American job growth because U.S. factories no longer make what China supplies, said UBS economist Dong Tao in a report this month. He said business would shift instead to Malaysia, Mexico or other low-cost suppliers.

“Unless the U.S. rebuilds its manufacturing base, China’s loss would not be the U.S.’s gain,” Tao wrote.

And the array of tensions with Washington over Taiwan, Tibet and the Internet could complicate Beijing’s timing by making some leaders reluctant to look like they were giving in to pressure, said Citigroup’s Peng.

“It will be very difficult for Chinese authorities to justify why they are allowing the currency to appreciate now,” Peng said. “Appreciation is still viewed as some sort of a concession.”