IN FOCUS

China has revalued its currency, the Yuan 2.1 per cent and linked it to a basket of currencies and has abandoned the11-year-old peg of its currency, the Yuan, at 8.28 to the dollar. China's decision followed escalating complaints from it's trading partners, particularly from the US and the EU, that the relatively cheap Yuan has created an unfair trade advantage for it, and follows reports that confirmed continued economic growth in the first half of the year. In the central bank's quarterly report, China's gross domestic product [GDP] grew from 9.4 per cent in the first three months of the year to 9.5 per cent in the second quarter. From now on, the Yuan will be linked to a basket of currencies, the central parities of which will be set at the end of each day. The currency has been revalued, although by nothing like as much as America and others have been demanding the Yuan's central rate against the dollar be shifted by 2.1per cent, to 8.11. The Chinese called it a managed floating exchange-rate regime, which may well imply more management than floating.

The Central Bank of China stressed that Yuan would be allowed to move in a tight range of 0.3 per cent up or down from the previous day's close the same flexibility China has had, but chosen rarely to use, since it adopted a managed float policy in 1994. The Japanese Yen leapt 2 per cent on speculation as 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. But Hong Kong, whose currency is also fixed against the dollar, said it has no intention of changing its policy. It is predicted, the Yuan to climb 10 per cent over the next year. Asian countries welcomed the new financial landscape made by the government of China in the file of its national currency. These currencies were uniformly tipped to appreciate in the long-term, following China's announcement that it had abandoned the Yuan peg for a managed float against an undisclosed trade-weighted basket of currencies. The region's economic growth rates were also expected to get a boost. It is predicted that China's move would inevitably be the start of a long process of the Yuan regime becoming more flexible. The most immediate impact came in Malaysia, which announced that virtually straight after China it had scrapped the Ringgit's seven-year-old peg to the dollar in favour of a managed float. An appreciating Renminbi would accelerate the current trend of appreciating Asian currencies while boosting the region's re-flatting economies.

Strong currencies should attract capital and discourage the export of savings, adding to demand for Asian assets." The Yuan, or Renminbi, was revalued at 8.11 to the US dollar compared to 8.28, a 2.1 per cent revaluation. It will be allowed to trade 0.3 per cent either side of a daily fixed rate and trade in a managed float against a basket of trade-weighted currencies. On its first day of trading, the Yuan closed slightly easier at 8.1111 to the dollar, its low for the day and off a high of 8.1100.

American politicians and policy makers, in particular, have been demanding 30 per cent to 40 per cent revaluation of Chinese currency. Japan, the largest economy in Asia and China's biggest trading partner, was one of the firsts to urge still greater Yuan flexibility, while welcoming the first step. A shift to a basket-trading system of the Chinese Yuan is positive for the Chinese and global economies. Economists are of opinion that China will eventually have to allow bigger movement flexibility for the exchange rate to reflect changes in the underlying currency basket. It will give a better buffer to Asian economies to absorb any sort of external shocks so those are positive developments for Asian economies and the world economy. Australian also welcomed China's decision and treated its "good" for Australia's exports and international markets. China is Australia's second largest export market and the revaluation of the Renminbi will make Australian exports cheaper, having a positive impact especially on resources and agriculture products. In Malaysia, the business community expected the Yuan-triggered revaluation of the Ringgit was an important step in making the country a more attractive destination for investors.

The increasing investments of China ($700 billion of foreign reserves) in the primary and secondary money markets of USA have already threatened the policy makers of the West and especially the USA. The $18.5 billion contested bid by CNOOC, a big Chinese oil company, for America's Unocal is causing an uproar in USA. China's recent move may dampen calls for trade protection and revaluation for a while. It is manipulated that such a slight revaluation is unlikely to do much to slow China's fast-expanding economy. According to Central Bank of China (2005) that GDP in the second quarter of 2005 was 9.5 per cent higher than a year before, more than most regional and global economists and financial pundits had forecast and only a shade less than the figure for the same period of 2004. Industrial production, ahead by 16.8 per cent in the year to June, and investment in fixed assets, up by 25.4 per cent in the first half, year on year, have both eased from their levels at the end of 2003, but remain strong. Inflation, as measured by the consumer-price index, is mild. It slid to 1.6 per cent last month, down from 5 per cent-plus a year ago.

China's new currency policy is a much more stable arrangement for the world financial system. It will help China to relieve the tensions that have been building from failed sterilisation tactics the inability of China to issue enough domestic debt to offset the massive purchases of US Treasuries required by the new abandoned dollar peg. A managed float provides China with much greater discretion on the sterilisation front, thereby tempering the excesses of its domestic financial system. By moving to a currency basket, China will need to diversify its enormous portfolio of foreign exchange reserves, which totalled some $700 billion at the end of 2005. Other Asian central banks also massively overweight dollars should follow China's lead. By abandoning its peg, China is sending a clear signal that its natural demand for dollar-denominated assets is likely to be reduced. It is predicted that China's trade weights would imply only 27 per cent weight of the dollar in the new currency basket. Adding in the still dollar-pegged Hong Kong currency would raise the dollar weight to about 50 per cent well below the current 64 per cent portion that the BIS would impute to the dollar-denominated share of official reserves.