China's RMB Peg to End

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Will they, won’t they goes the guessing game and that’s rather how the last year has been with China’s exchange rate. We have said in previous posts we expect China to revalue the 6.83 RMB peg against the US dollar sometime this year, the question is when.

Well two recent reports only add to the confusion. In one article, Chinese Premier Wen Jiabao categorically stated in his address to the National Peoples Congress, China’s equivalent of the State of the Union address, that there would be no immediate yielding on the currency which he said would be kept “basically stable.

Yet a separate FT article reports comments from the country’s central bank chief Zhou Xiaochuan who hinted they are considering “exiting the special policies introduced to weather the financial crisis – meaning the dollar peg. He went on top say the current dollar peg is temporary.

The divergence of position should probably best be viewed as a difference of internal opinion, some in China, notably the senior politicians are more concerned about domestic employment and public support, whereas the technocrats in the Ministry of Finance realize China must address its trade balances with the rest of the world. It can either do this by allowing inflation to rise, which will reduce domestic competitiveness and hence reduce exports or it can allow the exchange rate to rise which will reduce the cost of imports, suppress inflation but still reduce the competitive position of Chinese exporters. Either way export companies are going to be hit but the second route is much more controllable and ultimately in China’s best interests if it wants to stimulate domestic consumption and reduce reliance on exports. Headline inflation is under control in China. Prices are expected to have increased 2.3% in February year over year, but other areas have exploded. The value of property sold in 2009 rose 75.5% from the year before, representing just 42.2% increase in actual floor space sold.

In fact, it is the fears of inflation and asset bubbles that may be the primary driver behind any change of heart regarding the currency. The dilemma for Beijing is they have made such a big thing about not being seen to bow to western pressure to revalue that any move now will be seen as a climb down regardless of what justification they give for it.

–Stuart Burns

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