Beijing: China may allow the yuan to trade freely after Beijing hosts the Olympics next year, seeking to curb excessive lending and cool the economy, said Suan Teck Kin, an economist at United Overseas Bank Ltd
The government will probably allow a so-called free-floating currency a year after reshuffling its leadership in October, Singapore-based Suan said in an interview.
He predicts the currency will strengthen 1.9% by the end of the year to 7.43 per dollar and 6.9% to 7.08 by the end of 2008.
Restrictions on inflows and outflows of money for investment purposes, or the capital account, now allow the central bank to dominate the currency market. Sales of yuan have limited its gains to 9.4% since the end of a dollar link in July 2005, not enough to fend off a threat of sanctions from US lawmakers. “They have to adopt a free-float system; it’s not a question of whether they will, but a question of when,” said Suan at United Overseas, Singapore’s second biggest bank. “After the Olympics, the new leadership will be firmly in place.”
The yuan had its biggest weekly gain since the end of the fixed exchange rate in the five days ended 13 July. The currency closed at 7.5678 against the dollar in Shanghai at 5:30pm.
China allowed the yuan to be freely convertible under the current account in December 1996, removing limits on the use of foreign exchange for trade in goods and services. The government limits the exchange of currency for investment. Foreign companies have won approvals to invest $10 billion (Rs40,400 crore) in China’s stock and bond markets, while domestic investors have been awarded $15 billion of such quotas to buy securities overseas.
China will avoid major policy changes before President Hu Jintao picks a new leadership for the next five years at an October party congress.
The government will seek to avoid economic disruptions before the Olympics starts in the capital on 8 August 2008. “After the Olympics—the big event—is out of the way, it’s time to focus on other issues,” Suan had said on 12 July.
China maintains its goal of allowing full convertibility of the yuan, central bank governor Zhou Xiaochuan had said on 23 June.
A free-floating yuan is unlikely to exist after the Olympics because there needs to be enough derivatives products for traders and banks to hedge against foreign exchange risks, said Ma Jun, an economist at Deutsche Bank AG in Hong Kong. “It will take at least five years,” Ma said. “It requires a range of institutional reforms and strengthening of risk management. It also requires a broad balance of supply and demand for the currency.”
Forwards and swaps are currently the only two products in China’s yuan derivatives market. Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or the weather.
“The yuan will eventually become fully convertible, but the process will be gradual,” Cheng Siwei, vice-chairman of China’s legislature, the National People’s Congress, had said at an investment forum in Beijing on 14 July.
The government will eventually allow the free float of the yuan but it is “meaningless” to speculate on when that will happen before China liberalizes its capital markets, said Zhao Qingming, an analyst at the China Construction Bank Corp., China’s third largest bank. He was formerly a central bank researcher. “When the yuan is allowed to float will depend on the health of the Chinese economy,” he said. “Reform to let the yuan float is definitely something the central bank has to do.”
Higher volatility in the yuan suggests a prelude to letting the yuan float, Suan said. The currency rose more than 0.2% twice last week and fell for the other three days. “China wants to increase yuan volatility for the eventual lifting of the managed appreciation.”