China finally bowed to two years of political and market pressure by revaluing the yuan by 2.1 percent and leaving the door open to further rises by abandoning the currency’s decade-old peg against the dollar.
Analysts described the long-awaited move as modest and said it would have a limited economic impact. But they said the shift, ahead of a US visit in September by President Hu Jintao, made good political sense and potentially marked a critical step by China’s policy makers toward giving more play to market forces.
“The most important thing is the change, not how much it changed,” said Li Yang, a senior economist with the Chinese Academy of Social Sciences in Beijing.
After keeping the yuan virtually fixed near 8.28 per dollar since 1996, China said that it was adjusting the currency’s value to 8.11 and tying it from now on to a basket of currencies of China’s main trading partners.
The central bank said the yuan would be allowed to move in a tight range of 0.3 percent up or down from the previous day’s close - the same flexibility China has had, but chosen not to use, since it adopted a “managed float” policy in 1994.
The Japanese yen leapt two percent on speculation other Asian governments, afraid until now of giving China a competitive edge, would let their currencies rise on the yuan’s coat-tails.
Malaysia promptly did just that, scrapping the peg that had frozen the ringgit since 1998 and switching like China to a managed float.
With China’s initial revaluation falling well short of the 10% move that Washington had been seeking, dealers immediately started to wonder whether this would be the first in a series of gradual moves.
“It’s just a gesture. The question now is whether there will be continuing speculation that China may revalue even more,” said Ben Kwong, an analyst from KGI Asia in Hong Kong. Frank Gong, chief economist for JP Morgan Chase in Hong Kong, said he expected the yuan to climb 10%t over the next year.
But a spokesman for the central bank said big movements in the yuan would harm the economy, which has become a major engine of world growth since China threw its markets wide open by joining the World Trade Organization in 2001.
China had long insisted that it would adopt a more flexible exchange rate system, but not until it was ready.
In March Premier Wen Jiabao impishly said the timing of a move would be a surprise and has since reacted testily to calls for a shift, saying the question touched on China’s sovereignty.
Foreign pressure has been especially intense in the United States, where many law-makers blamed their country’s $162 billion 2004 trade deficit with China on an artificially cheap yuan, which they said handed Chinese exporters an unfair advantage.
Senators were preparing a bill that would have slapped a 27.5% tax on Chinese imports if Beijing did not revalue but last month delayed a vote on the measure after US Treasury Secretary John Snow and Federal Reserve Chairman Alan Greenspan said it would be counterproductive politically.
“It maybe relieves the pressure from the U.S. with tariffs on the table in Congress, but it remains to be seen if it is enough politically and economically. It is not going to change the trade position,” said Mark Cliffe, chief economist at ING in London.
Greenspan, too, has said a yuan revaluation would have minimal impact on the US trade deficit, but he and others had urged China to adopt a more flexible currency for its own sake.
Economists said the money from China’s fast-growing trade surplus, on top of a flood of speculative money into China betting on a revaluation, had been making it harder for China to manage its monetary policy and would eventually stoke inflation.
To keep the yuan’s exchange rate fixed, China has had to buy up huge quantities of dollars. Its foreign exchange reserves swelled to $711 billion at the end of June, the world’s largest stockpile after Japan’s. Much of the money has been invested in US bonds, helping to keep US interest rates low.
The central ban