The Yuan in 2010: How Low Will it Go?

Will China revalue the Yuan in 2010? This is the question of all questions – and it seems that every China watcher and major economist has an opinion.

But who actually knows? I believe the Yuan will stay put – for now – and will not be revalued in the short term.

More on my forecast a bit later. First, some context.

Before delving into the prognostications about China’s currency revaluation by the China watchers and economists, it’s important to provide some much-needed context to this important issue:

• China is the world’s third-largest economy and is export-focused; Goldman Sachs has maintained its forecast for 11.4 per cent growth in 2010 compared to 8.7 per cent last year with exports playing a critical role in determining China’s growth.

• China revalued the Yuan in 2005 when it set the Yuan against a basket of currencies and allowed the currency to appreciate. By July of 2008, the Yuan had appreciated by 21 per cent compared to its July 2005 level. Appreciation of the currency was halted in the wake of the global financial crisis in the fall of 2008.

• The Yuan currently stands at 6.82 per 1 US Dollar, compared to 8.2 Yuan per 1 US Dollar in the summer of 2005.

• China’s legislative bodies – the NPC and CPPCC convenes in March 2010.

The decision to revalue the Yuan (beyond the 21 per cent it strengthened between 2005 and 2008) must be viewed as a political issue as much as it an economic one.

China’s Government is determined to maintain a “harmonious society” and robust yet not “out of control” economic growth is critical to realising this.

Thus, China must strike a balance between overheating and a slowdown. And, with recent signs of an overheating Chinese economy, some think it would make sense to put the brakes on a bit and revalue the Yuan. We already know where the Obama administration stands on this position: the US is exerting great pressure on China to revalue the Yuan.

The crux of the US’ argument is that an artificially undervalued Yuan protects the Chinese market from imports while giving Chinese exports a decided advantage. And, exports are critical to China’s economic growth.

While there are solid economic reasons to move quickly, there are also some solid political reasons to stay put.

The US has been loudly calling for the Chinese to let the yuan appreciate. For instance, President Obama said in an interview with Bloomberg BusinessWeek, “China and its currency policies are impeding the rebalancing [of the global economy] that’s necessary. My goal over the course of the next year is for China to recognise that it is also in their interest to allow their currency to appreciate because, frankly, they have got a potentially overheating economy.”

The president is right, but China’s leaders are probably in no mood to give an inch to the US right now. They’re still fuming over the arms sales to Taiwan, US criticism of China’s Internet censorship and a meeting between Obama and the Dalai Lama.

A change in currency policy now would be a big win for Obama – and might lead people in China and overseas to conclude that putting pressure on Beijing works. So even if a revaluation of the yuan is in China’s interest, it probably isn’t going to happen for a while.

As a result of the recent cool down measures, some influential China watchers and economists believe China will revalue the Yuan – and very, very soon.

Goldman Sachs’ chief economist Jim O’Neill recently told Bloomberg that “I have a strong opinion that they’re close to moving the exchange rate…Something’s brewing. It could happen anytime.” His comment was made as a result of China’s central bank – the People’s Bank of China – ordering Chinese commercial banks to increase their reserve holdings.

In addition to Goldman Sachs’ Jim O’Neill, a host of other commentators and stakeholders have supported the theory that China will revalue the Yuan. Stephen Jen of BlueGold capital Management LLP told Bloomberg that China may let its currency appreciate by 5 per cent as early as March (now). Jen also believes that policy makers will raise interest rates to cool the Chinese economy.

In Davos, Zhu Min, deputy governor of China’s central bank said: “China is a developing country and also a big country and stability is very important there…There are 1.3 billion people. They need jobs. Seventy per cent of GDP is services we trade. A stable exchange rate, when a crisis comes in, is good for China, also for the world."

I believe the Yuan will stay pegged for the time being and we should not expect a one-off revaluation of 5 per cent. China will wait for the rest of the global economy to improve and for global demand to return to pre-crisis levels.

Any change in exchange policy will need to be conducted on a multilateral level – with domestic growth considerations and international political considerations in mind.

These will be gradual, ongoing discussions through international bodies – in the meantime, don’t expect a revaluation of the Yuan.

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