China's caution on yuan signals no early move

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Investors betting on a yuan rise early next year will be disappointed as China is likely to keep the currency on a tight leash at least until the middle of 2010 to cement the country's economic recovery.

Annual growth in the world's third-largest economy accelerated to 8.9% in the third quarter, rapidly rebounding after hitting a trough of 6.1% in the first quarter and putting the government's full-year target of 8% within reach.

But comments from top Chinese officials attending a meeting of Asia Pacific Economic Cooperation (APEC) countries in Singapore highlighted their worries over the strength of the recovery, which remains nascent and stimulus-driven.

At the heart of their concern is the weakness in exports, which analysts say hold the key to any move in the yuan. Exports are unlikely to regain a solid footing until well into 2010.

Assistant Finance Minister Zhu Guangyao said a 4 trillion yuan stimulus package as well as a stable yuan policy contributed to the quick rebound in China, which was leading the global recovery.

Jiang Jianqing, the chairman of the country's biggest commercial lender the Industrial & Commercial Bank of China, echoed Zhu, saying a stronger yuan would not be conducive to the global recovery and the stable currency should not be changed abruptly.

Such policy signals suggest Beijing may not tinkering with the yuan until the second half of 2010 and any rise would be a gradual one, analysts say.

"If China's economy recovers further, the yuan may remain largely steady or strengthen slightly. But if China continues to face pressures on export front, it's unrealistic to demand China to let the yuan appreciate," said Zhao Xijun, an economist at Renmin University in Beijing.

No Early Appreciation

Speculation of an early yuan rise increased last week after the central bank said in its quarterly report that it would consider major currencies -- not just the dollar -- when guiding the exchange rate.

But a state-run newspaper on Friday played down speculation of an imminent rise in the yuan and a Commerce Ministry spokesman said on Monday that China should keep the yuan stable, reiterating a long-held view.

Morgan Stanley's China economist Qing Wang said the latest comments signalled that any early yuan move was unlikely.

"While we believe an exit from the current regime of a de facto peg to the dollar may occur in the second half of 2010, any subsequent renminbi appreciation against the dollar is, in our view, likely to be modest and gradual," he said in a note.

The yuan fell slightly in non-deliverable forwards (NDFs) on Monday as investors pared back their expectations of an early yuan appreciation, but six-month NDFs are still pricing in a 1.5% yuan rise from the spot rate.

One-year dollar/yuan NDFs imply a 3.4% yuan rise from the spot compared to 3.6% on Friday and the late October high of 4.55%.

Woon Khien Chia, strategist at Royal Bank of Scotland, said the NDFs is at fair value after the recent retreat and any yuan move is unlikely to happen before the U.S. Federal Reserve starts raising interest rates -- widely seen in the second half of 2010 -- given it could trigger a rush of hot money inflows.

Concerns about an overheating economy was the key catalyst for Beijing's landmark yuan revaluation in July 2005, when the central bank revalued the yuan by 2.1% to 8.11 per dollar.

Since then, the yuan gained almost 20% against the dollar until mid-2008, when the gradual rise came to a halt as China's exports took a severe hit from the global downturn. It has been held around 6.8 per dollar.

Despite the current recovery, exports are still contracting compared with a year earlier, with those in October slipping a steeper-than-expected 13.8% after a 15.2% fall in September.

Beijing officials says exports may return to growth from early next year, although it will be mainly due to a low base of comparison.

China is under pressures from the United States to let the yuan rise to rebalance the global economy, but Beijing insists that exchange rates only play a supporting role in reducing its trade surplus and has pledged to boost consumption.

An APEC communique issued at the end of two days of talks on Sunday dropped a reference calling for "market-oriented exchange rates" after Washington and Beijing failed to agree on the wording, according to an APEC delegation official.