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China to budge on yuan in Q2 but check its rise

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China to budge on yuan in Q2 but check its rise
26 Mar 2010, 1444 hrs IST, REUTERS

BEIJING: China will resume yuan appreciation in the second quarter but will keep its currency on a short leash, allowing a mere 3 percent rise
US-China Yuan Battle
over the next 12 months, according to a poll.

Economists also forecast that while China's central bank was now in tightening mode, its actions would be gradual and mild, with interest rates rising only twice in the next year and banks' required reserves increasing three times during that period.

But, more than ever before, all eyes will be on the yuan.

China has effectively pegged its currency to the dollar since mid-2008 to cushion its exporters from the financial crisis, a policy that has come under growing fire from Washington, where lawmakers have threatened punitive duties against Chinese products.

This pressure is counter-productive and is only likely to delay any decision to appreciate, according to 61 percent of poll respondents.

Nevertheless, the median forecast of 45 economists was for Beijing to give ground soon, if only just.

The yuan will be locked at 6.83 to the dollar throughout April before being allowed to rise to 6.80 by the end of June. It will reach 6.60 by the end of March 2011, a total rise of 3.4 percent over the one-year period.

By comparison, the offshore forwards market on Friday was pricing in a rise in the yuan of less than 2.35 percent over the next year.


If President Barack Obama's administration labels China a "currency manipulator" in a report due on April 15, Beijing would not want to move on the yuan for a few weeks, said Mark Williams, an economist with Capital Economics in London.

But in a couple of months, with exports recovering and inflation edging up, allowing the yuan to start climbing again might seem a desirable policy option. Beijing let the currency gain 21 percent against the dollar between July 2005 and July 2008.

"China will do what is best for itself and I'm not convinced U.S. criticism should or will make much difference," Williams said.

Nevertheless, economists who are predicting a resumption of the yuan's rise may, to a certain extent, be guilty of wishful thinking.

The forecasts for yuan appreciation over a one-month, three-month, six-month and 12-month time horizon were nearly identical to those in the previous quarterly poll in early January. Since then, Beijing has not budged at all.

Facts on the ground have changed this time, notably in the mounting spat with the United States as well as the rise in Chinese consumer price inflation to a 16-month high of 2.7 percent in the year to February.

"Presumably China will eventually see the usefulness of yuan appreciation as a way to contain inflation," said David Cohen, economist with Action Economics in Singapore.

"I assume that the U.S. can keep the rhetoric sufficiently controlled so that it does not cause Beijing to hold off appreciation any longer than they would otherwise. I think that they both would rather not see this get out of hand."


China's reluctance to tolerate a stronger exchange rate is, in large part, a function of concerns about the solidity of the economic recovery as uncertainties about global demand and private sector investment linger.

Fan Gang, an adviser to the central bank
, said in remarks published on Friday that domestic factors such as employment would also weigh heavily in the balance when deciding whether to reintroduce greater exchange-rate flexibility.

Doubts about economic prospects were reflected in the poll's outlook for monetary policy more broadly over the next 12 months.

Economists forecast the People's Bank of China will raise interest rates once in the second quarter. That would be the first increase since Dec. 2007 and would begin to unwind the 216 basis points of lending rate easing delivered during the global financial crisis.

Over the subsequent 9 months, though, the poll pointed to just one further interest rate increase, putting rates 54 basis points higher at this time next year.

Economists expected similar gradualism on required reserve ratios. The central bank will move this month to raise the proportion of deposits that banks must hold on reserve and then increase them just twice more over the next year.

That means the country's biggest banks would face reserve requirements of 18 percent in one year, up from 16.5 percent now.

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