Yuan's so called flexibility - How's Yu an I affected?
A June 19, 2010, statement from the People's Bank of China (PBoC) suggested that China will reform the Yuan (RMB) exchange rate and enhance the RMB's exchange rate flexibility in view of "the recent economic situation and financial market developments at home and abroad." The statement represents a departure from a two-year period during which the RMB was effectively pegged to the dollar. PBoC statements of recent months have included references to the fact that the stable exchange rate was one of the anti-crisis policies introduced in 2008 to help support economic recovery and thus would eventually be removed. Though we don't expect the Yuan to appreciate more than 3% in a year's time, there can be several implications to this move.
What does this mean to the Global Markets?
Imports getting cheaper for China means increasing demand from the rest of the World (see chart below). Mature economies, who are about to embark on a program of a meaningful and sustained fiscal tightening, this demand lift from China can be useful.
This gives the EUR a little more scope to devalue vis-à-vis the Yuan, without tampering with the cross with USD.
China being the world's largest buyer of key base metals like copper and aluminum (consuming about 40% of the total global supply), a stronger Yuan would translate into even higher imports, thus pushing the commodity prices northwards. This, however, would be a short-term move, as the potential slow down of the Chinese economy will offset the above.
This obviously brings in a lot of joy for China's competitors and trading partners, who have long complained that the Yuan gave Chinese exporters an unfair advantage, fostering global imbalances.
The following graph captures the % change in Chinese imports during July 2005-08, during which the Yuan was allowed to appreciate.
Source: DOTS, IMF
.. and for China?
A more flexible currency would give China more freedom to decide on monetary policy and reduce inflationary pressures by lowering import costs. China's inflation jumped to a 19 month high of 3.1%YoY in May.
Beijing based computer maker Lenovo Group Ltd. and Shanghai based China Eastern Airlines Corp says that they would gain from lower imports costs. Textiles makers, on the other hand, would stand to lose most and some may face bankruptcy with profit margins as low as 3%.
The PBoC probably aims at lowering dependence of growth on exports (other than investment) and pass it on to domestic consumption, led by higher purchasing power of consumers (as imports become cheaper and inflation gets checked). This structural change in the Chinese growth story, we believe, is key for the country's sustainable growth process.
