China Slightly Loosens the Reins on Its Currency’s Market Fluctuation

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May 19, 2007
China Slightly Loosens the Reins on Its Currency’s Market Fluctuation
By KEITH BRADSHER
HONG KONG, May 18 — China’s central bank announced Friday that it would begin allowing the country’s currency to fluctuate more during each day’s foreign exchange trading, but again rebuffed demands from the United States and Europe for a sustained rise in the currency.

The central bank also raised interest rates and demanded that commercial banks set aside more of their assets as reserves that cannot be lent. Both of the moves are aimed at reducing the risk of overheating in an economy that is growing at more than 11 percent and at taming speculation in domestic stock markets that have more than tripled since the beginning of last year.

The announcement came as top American and Chinese economic policy makers prepared to meet next week in Washington in an effort to head off growing pressures from Congress to confront China over the widening American trade deficit.

But economists said that the latest policy moves, which take effect on Saturday, were unlikely to have any practical effect on China’s soaring exports, while the initial reaction from Washington was cautious.

The People’s Bank of China said in a statement posted on its Web site (http://www.pbc.gov.cn/english/detail.asp?col=6400&id=837) that it would allow the country’s currency, known as the yuan, to rise or fall up to 0.5 percent in each day’s trading. The current daily limit is 0.3 percent.

But the central bank gave a clear signal in its statement that the policy should not be interpreted as Chinese willingness to allow a run-up in the value of the yuan. The bank said it would continue to “keep the exchange rate basically stable at an adaptive and equilibrium level based on market supply and demand with reference to a basket of currencies.”

The bank issued a separate statement quoting an unidentified spokesman as saying that the decision did not mean that the exchange rate “will see large ups and downs, nor large appreciations.”

The People’s Bank has not allowed the yuan to move the maximum allowed percentage on any day since it broke the yuan’s peg to the dollar on July 21, 2005. The Chinese government allowed the yuan to rise 2.1 percent then, and has let it inch up by only another 5 percent over the nearly two years since.

In contrast, members of Congress from manufacturing states that have lost jobs during China’s export boom have been calling for China to reval‎ue by 25 percent or more. If China did allow the yuan to rise more quickly, Chinese exports would become more expensive in foreign markets and foreign goods would be more competitive in China.

Liang Hong, an economist in the Hong Kong office of Goldman Sachs, said in a research note that the wider trading band represented “a symbolic but laudable development in China’s foreign exchange reform.”

The initial reaction from Congress was chilly. “To widen the band is well and good, but if they don’t use the band, nothing will happen,” said Senator Charles E. Schumer, the New York Democrat who has called for steep tariffs on goods from China unless Beijing lets the yuan rise.

The Bush administration was also cautious but a little more welcoming. “This is a useful step towards greater flexibility and an eventual float of the currency,” said Brookly McLaughlin, a Treasury spokeswoman. “It’s important now that Chinese authorities use the wider band and allow greater currency movement within each day and over time.”

Stephen Green, an economist in the Shanghai office of Standard Chartered Bank, said that China was likely to allow slightly faster appreciation in the next few days but that the long-term rate of appreciation would not change. There have been just two single-day rises of 0.16 percent and two single-day drops of 0.17 percent in two years, while the rest of the trading has fallen within an even narrower range, he added.

Widening the daily trading band is nonetheless the latest and most noticeable in a long series of steps by Chinese officials to gently awaken businesses to the risks that fluctuating currencies can pose. China pegged the yuan at 8.28 to the dollar from 1997 to 2005, lulling some businesses into ignoring currency risk.

In interviews last month at the Canton Fair, exporters from all over China said that they were paying closer attention to exchange rates. While Chinese export contracts are still denominated mainly in dollars, Chinese companies increasingly demand that their foreign customers agree to provisions requiring the buyer to pay extra if the dollar starts falling faster against the yuan.

Chinese officials acknowledge that there are arguments for faster appreciation of the yuan, but contend that this could threaten “social stability.” Chinese workers making goods like textiles that compete with exports from even lower-wage countries could protest if currency appreciation makes their products uncompetitive and costs them their jobs.

Two-thirds of China’s population still lives in rural areas and the agricultural sector is barely competitive with imports at current currency levels, raising the prospect of increased rural unemployment if the yuan rose sharply and food imports surged.

The People’s Bank of China also announced on Friday that it was raising the benchmark regulated rate for one-year bank deposits by 0.27 percentage point, to 3.06 percent, and increasing the benchmark rate for one-year bank loans by 0.18 percentage point, to 6.57 percent.

By raising deposit rates more than lending rates, the government showed confidence that the banks had put enough of their bad-loan problems behind them to survive on slightly narrower profit margins. Higher deposit rates also make it a little more attractive for Chinese families to put their savings in banks, instead of risking them in China’s feverish stock markets.

But raising domestic lending rates could make it harder for China to allow further appreciation of the yuan.

That is because the central bank is itself a borrower. It borrows yuan, by issuing bonds, to pay for its extensive interventions in currency markets, where it has accumulated $1.2 trillion in foreign exchange reserves, mainly dollars.

The central bank earns a higher interest rate on American Treasury securities than it pays on yuan-denominated bonds at home. The authorities use this profit from the difference in interest rates to cover losses on the foreign exchange reserves, which are worth less and less in yuan as the yuan appreciates.

The semiofficial China Business News newspaper reported on Friday that the government had entrusted $3 billion to the Blackstone Group, the private equity firm, to invest abroad. Blackstone declined to comment; the company is in a “quiet” period before a planned initial offering on the New York Stock Exchange.

The central bank also ordered banks to hold 11.5 percent of assets as reserves effective Saturday, up from 11 percent. Many banks already have even larger reserves, however, as they have been swamped with deposits from China’s brisk economic growth and large trade surplus, and have had trouble finding ways to lend this money.