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Chinese devaluation holds little fear

BEIJING: Just a year ago, talk of China tinkering with its currency exchange rate would have rung alarm bells around the world.

No longer.

Last week, a left-wing Hong Kong daily often used by Beijing to float trial balloons reported China might be ready to let the yuan trade in a wider range. The currency is now unofficially pegged to the dollar at around 8.28.

The knee-jerk reaction in Hong Kong was to fear a yuan devaluation and knock-on pressure on the Hong Kong dollar, itself tied to the US currency.

But on second thoughts, the idea has sounded far less intimidating. The latest wisdom from regional economists is that if China relaxed its grip on the yuan, the currency would probably go up, not down.

That kind of calculation highlights a sharp turnaround in the fortunes of the Chinese economy.

It also underlines economic recovery in the region.

For the past few years, Asian economies have lived in terror of a yuan devaluation triggering a new avalanche of cheap exports from China, which is rattling with industrial over-capacity.

And the prospect of tit-for-tat devaluations spreading around the globe has alarmed just about everybody.

NO TIME LIKE THE PRESENT

If China does intend to give the yuan a longer leash, there may be no time like now.

China's balance of payments are healthy and Asia is rebounding. The US economy is still powering ahead and Europe is strong too.

"China is thinking, 'If I have to do something, I'm better off doing it now while things are going well'," said Steve Xu, the Hong Kong-based regional treasury economist for Standard Chartered Bank.

"The longer you do nothing, the more people will think there's something wrong with China if you have to do something."

Besides, said Xu, the peg is starting to look "a little bit ridiculous".

Chinese foreign exchange reserves are now at around $155 billion and on Monday the State Statistical Bureau reported economic growth this year would at least match last year's 7.1 percent, in part powered by exports.

The peg to a strong US dollar is becoming increasingly awkward for a country that conducts two thirds of its foreign trade with economies which maintain floating exchange rates.

Its rigidity offers no buffer to external shocks.

And it has bred a host of economic distortions. For instance, during the Asian economic crisis, when a strong yuan was hitting Chinese exporters particularly hard, the government felt obliged to offer export subsidies to ease the pain.

The subsidies persist, even though many exporters could now live without them.

BEATING THE CONTROLS

Some argue broadening the yuan's trading band is largely pointless in a country with a closed capital account - and nobody in China has suggested tight controls in that area should be relaxed immediately.

But this may be underestimating the knack of Chinese businesses and investors for moving capital in and out of the country.

In some cases, it is as easy as stuffing a suitcase with Chinese currency and walking over the border to Hong Kong, where the yuan is freely accepted by banks and money-changers.

Under-invoicing by importers and "round-tripping" a ploy through which Chinese money leaves the country and loops back in disguised as foreign invesment are other popular ways of beating the controls.

"The capital account is not bullet-proof," said Xu.

"The Chinese economy is a lot more open than people think."

OLD NEWS?

Not everyone is convinced Beijing really is planning to liberalise the exchange rate system any time soon, even though a spokesman for the People's Bank of China confirmed to Reuters the move was under discussion.

"It's old news," said Hu Biliang, a senior economist for SG Securities Asia Ltd in Beijing.

"The idea is there, but I don't think it'll be implemented this year."

Hu said before the trading band was slackened, the government would want to bring more players into the foreign exchange market, now dominated by the Bank of China and, through its intervention, the central People's Bank of China.

Also, said Hu, Beijing wanted to free up bank interest rates first, a precondition for a more flexible exchange rate.

Even those who predict Beijing will make the leap say it is unlikely to occur until later in the year.

The attention of Chinese policy-makers is now consumed by March 18 presidential elections in Taiwan, by the annual meeting of the Chinese parliament, which opens on Sunday, and by China's efforts to wrap up trade talks with the European Union and enter the World Trade Organisation.

One Beijing-based economist said he was expecting a 10 percent trading band five percent in each direction from a mid-rate set each day.

"My gut feeling is that it's going to happen," he said.

"I think they're working themselves up to something this year."-Reuters