Chinese Yuan XR volatility – Q and A

Reuters published an interesting analysis of the recent depreciation of the Yuan here, including implications, dangers and analyst expectations.  It’s copied here below.

If depreciation is market driven, a big if, then the depreciation may be appropriate and help revitalise Chinese exports and in turn western consumption.  Whether or not the value has been engineered, it is not dissimilar to the gross fluctuations of other currencies that have been seen over the past few months, eg US$, €, Yen, GBP etc.

Unfortunately only the traders benefit from this kind of volatility, whether it be in currency, stock or asset prices.

Q+A-Why is speculation over China’s yuan heating up?

Thu Dec 4, 2008 2:24am EST

(For related stories see MARKETS-CHINA-YUAN-MIDDAY or [ID:nSHA270570]; CHINA-USA/ or [ID:nPEK36920])

Dec 4 (Reuters) – U.S. officials are expected to urge China to engineer appreciation of the yuan <CNY=CFXS> against the dollar at a two-day Strategic Economic Dialogue between the countries, which opened in Beijing on Thursday.

But the yuan has instead weakened against the dollar this week to a five-month low and the currency market is speculating that it will drop further.

China has not confirmed any policy change, but most traders believe official thinking has shifted to a degree.

Here are some facts about the long-simmering spat over the value of China’s currency.

WHY IS THE YUAN IN THE NEWS?

* This week has seen the greatest turmoil in China’s foreign exchange market since the yuan’s fixed peg to the dollar was scrapped in July 2005.

* After keeping the yuan within a tiny range of about 6.82-6.85 against the dollar for four months, China’s central bank let the yuan drop unusually sharply this week.

* It was trading at 6.8837 per dollar at 0717 GMT on Thursday.

* The yuan’s value is tightly controlled by the Chinese central bank; it sets a daily mid-point <CNY=SAEC> against the dollar, and trades against the dollar can only occur in a band extending 0.5 percent either side of the mid-point.

WHAT’S BEHIND THIS WEEK’S MOVES?:

* Domestic political pressure to help the country’s struggling export sector is believed to be a major factor. Thousands of small factories making shoes, clothes and toys have closed in recent months, raising unemployment and sparking worker protests which the government says threaten social stability.

* Many factories were pushed into the red as the yuan appreciated over 7 percent against the dollar earlier this year to a peak of 6.8099 in September, analysts say.

* Depreciating the yuan would make made-in-China goods cheaper, better insulating exporters from global recession.

WHAT ARE THE INTERNATIONAL IMPLICATIONS?:

* Engineering a yuan rise against the dollar would help ease trade tensions with the United States, which runs a significant deficit with China. The two countries’ lopsided trade relations are closely watched, and may reflect a shift of global economic power to East from West.

* Critics of China, such as U.S. manufacturers, say it has kept the yuan undervalued, giving its firms an unfair advantage in world markets that has cost millions of jobs in the West.

WHAT’S DANGEROUS ABOUT A DEPRECIATION?:

* DOMESTICALLY — Extended, sharp depreciation could prompt capital outflows from China, complicating the central bank’s efforts to bring interest rates down to help the economy. The central bank has declared it is determined to prevent large-scale outflows.

* INTERNATIONALLY — A big drop by the yuan could set China up for a confrontation with U.S. President-elect Barack Obama, who said in September that the yuan was “artificially low” and that he would press for appreciation.

* REGIONALLY — Yuan weakness could trigger competitive depreciations of other Asian currencies, worsening instability in global markets. During the Asian crisis of 1997/98, China’s decision to keep the yuan steady against the dollar, as other emerging market currencies tumbled, helped the region recover.

WHAT DO ANALYSTS THINK WILL HAPPEN?:

* The yuan may not be allowed to fall below 6.90 before the end of this year, according to a dozen dealers and analysts informally polled by Reuters in Shanghai this week.

* It could depreciate as much as 3 percent further in the first half of 2009, to around 7.1 — but only if the dollar continues to rise globally and if China’s economic downturn continues to worsen, they said.

* To fend off charges of currency manipulation from trading partners, China could simultaneously begin reforms to its currency system, such as widening the yuan’s trading band to 1.0 percent on either side of the daily mid-point, traders think.

Source: Reuters

(Compiled by Gillian Murdoch, Singapore Editorial Reference Unit; Editing by Andrew Torchia)

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