China doubling yuan band signals drive for convertibility

Increase to 1% from 0.5% takes effect on April 15

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April 15 (Bloomberg) -- China’s decision to widen the yuan’s trading band against the dollar for the first time since 2007 signals a drive toward a convertible currency that also saw overseas investors get bigger investment quotas this month.

The increase to 1 percent from 0.5 percent takes effect tomorrow, the People’s Bank of China said on its website yesterday. This month, regulators raised quotas for foreigners buying onshore stocks and bonds to $80 billion from $30 billion and increased the amount of yuan held offshore that can be invested locally.

Chinese officials pledged in a five-year plan running through 2015 to keep loosening controls on currency flows as Premier Wen Jiabao targets higher domestic consumption and an enlarged global role for the yuan that would curb the dollar’s dominance. Mizuho Securities Asia Ltd. said yesterday that moves including the increased investment quotas indicate that the government is stepping up the pace of its efforts.

“Greater two-way exchange rate risk makes possible capital account opening, which would be a logical next step,” said Tim Condon, chief Asia economist at ING Financial Markets in Singapore. “If so, we are in the early stage of what will be as momentous for China” as the nation joining the World Trade Organization in 2001, he said.

Trading Band

The previous broadening of the trading band, which is centered on a rate set daily by the central bank, was from 0.3 percent in May 2007. Gains in the currency against the dollar have stalled this year as China’s growth slows and officials say that the yuan may be near “equilibrium.”

“It’s a positive decision and one that the market has long waited for,” Helen Qiao, an economist at Morgan Stanley in Hong Kong, said yesterday. “But in the end, the most important thing to watch is how much of that band will actually be used.”

At Standard Chartered Plc, Shanghai-based economist Li Wei said yesterday that more “two-way variability” in the yuan is a pre-condition for opening the capital account because of the reduced risk of one-way capital inflows.

“High on China’s financial reform agenda is to increase its capital account opening to allow domestically trapped idle money to invest offshore for better uses and returns,” Li added.

The yuan ended last week at 6.3030 per dollar, up about 8.3 percent since the scrapping in June 2010 of an almost two-year peg imposed during the global financial crisis.

‘Work Steadily’

In a March 5 state-of-the-nation address, Wen said that the government will “work steadily” to make the currency convertible under the capital account and expand the use of the yuan in cross-border trade and investment.

Yesterday’s announcement came days before the International Monetary Fund and Group of 20 hold talks in Washington, forums used by finance chiefs to lobby China to let the yuan gain.

“This underlines China’s commitment to rebalance its economy toward domestic consumption and allow market forces to play a greater role in determining the level of the exchange rate,” Christine Lagarde, managing director of the IMF, said in a statement.

Expectations for a stronger currency dwindled in the past six months as Wen cut the country’s economic growth target, Europe’s sovereign-debt crisis hurt exports, and China’s trade deficit in February swelled to the biggest since at least 1989.

‘Political Year’

Political pressure may be a “main factor” in the latest move, said Ren Xianfang, a Beijing-based economist with IHS Global Insight Ltd., who added that this is a “political year” because of a looming U.S. presidential election.

While the yuan reached an 18-year high at 6.2884 per dollar on Feb. 10, President Barack Obama’s administration and U.S. lawmakers say the currency remains weak enough to give China, the world’s biggest exporter, an unfair advantage in trade.

The Obama administration is reviewing China’s announcement “very closely,” Ben Rhodes, a deputy national security adviser at the White House, told reporters in Cartagena, Colombia, where President Barack Obama is attending summit of Latin American leaders. “They’ve made some progress and we’d like to see more.”

China always tries “to offer something” before big international meetings, said David Smick, a former Congress staff member and chief executive officer at Washington-based consultancy Johnson Smick International Inc. “It’s like when you go to dinner you take a little gift,” Smick said in Berlin.

After keeping the exchange rate stable for a decade, China allowed its currency to strengthen 21 percent from July 2005 to July 2008, including an initial, single-day gain of 2 percent. Appreciation was then halted for almost two years to help exporters weather a global recession.

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