China allows currency to rise as inflation persists

SHANGHAI: China has allowed its currency to hit a series of record highs against the dollar over the past week in a move analysts say may signal a new strategy to combat the growing threat of inflation.

Beijing is anxious about the potential for social unrest as living costs rise, and about slowing in the Chinese economy at a time of renewed global financial peril.

And with other macro-economic tools threatening to stymie domestic growth, a climb in the value of the yuan -- which would make dollar-denominated imports like oil cheaper -- might help to keep a lid on prices.

It would also have the added benefit of easing tensions with the US, where lawmakers complain the strong currency gives Chinese exporters an unfair advantage.

In the run-up to a high-profile visit by US Vice President Joe Biden, Beijing has allowed the yuan to strengthen to record levels.

China allows the yuan to move 0.5 per ent on either side of a dollar trading midpoint set by the central bank each day.

But last week the unit rose 0.8 per cent against the greenback, and on Tuesday, the central bank set the currency's central parity rate against the dollar at a fresh high of 6.3925.

"While inflation remains the key issue amongst the highest levels of government in China, we will likely see appreciation of the CNY (Chinese yuan) persist," said HSBC in a recent report.

The central bank has repeatedly stated it would allow more yuan "flexibility", most recently in its quarterly report last week.

The China Securities Journal this week called for a broadening of the yuan's trading band against the dollar, saying a reduced reliance on US and European markets had lessened the potential impact of a more flexible yuan on exporters.

"The time is now ripe to widen the yuan's trading band against the US dollar in the foreign exchange market," said the newspaper, which is run by the official Xinhua news agency, in a front-page editorial.

The yuan has risen steadily against the dollar since mid-2010, when Beijing relaxed a de-facto peg to the US currency, imposed in 2008 to protect its exporters during the global financial crisis.

But it remains a source of friction with the United States, which along with other countries claims that the currency is still undervalued.

On several occasions in the past, Beijing has allowed the value of the unit to rise ahead of bilateral meetings with the US, but analysts say Biden's visit this week is not the main motivation for recent rises.

"Higher-than-expected inflation... together with less willingness to accumulate more foreign exchange reserves -- given the structural weakness in the US dollar -- are likely behind the recent rapid pace of yuan appreciation," said Chang Jian, an economist at Barclays Capital.

Zhang Ming, an economist at the Chinese Academy of Social Sciences, said the recent turmoil in global markets presented China with an opportunity to allow freer trading of the yuan and promote its status as an international currency.

The US debt crisis "is forcing us to reconsider the traditional model of the Chinese government keeping the yuan's exchange rate stable by accumulating foreign exchange reserves," he said.

China buys US dollars as capital flows into the country, mainly through its widening trade surplus, which expanded to US$31.48 billion in July.

That policy limits yuan gains and has caused China to accumulate the world's largest foreign exchange reserves at US$3.3 trillion.

Chang Jian, an economist at Barclays Capital, said China appeared less willing to accumulate more foreign exchange reserves given the weakness of the US dollar, which makes up the majority of the reserves.

She expects the yuan to rise to 6.30 to 6.25 to US$1.0 by year-end.

"With the safety of the US$3.3 trillion reserves at stake and mounting political pressures for reserve management, there has been a stronger case to be made in Beijing for reducing intervention and reserve accumulation, and allowing for more flexibility," she said. -- AFP