Q+A-Will China’s yuan strengthen much more this year?

By Lu Jianxin and Saikat Chatterjee

SHANGHAI/HONG KONG, Oct 25 (BestGrowthStock) – China’s yuan has
fallen against the dollar since a surprise interest rate rise
last Tuesday, halting what had been the quickest pace of
appreciation since its landmark revaluation in July 2005.

However, the Chinese currency is expected to resume its
ascent later this week, albeit in a controlled fashion, and
could hit 6.60 yuan per dollar by late November before Beijing
again slows its pace of appreciation.

Here are some questions and answers about the yuan’s
outlook.

WHERE IS THE YUAN HEADED FROM HERE?

The yuan (CNY=CFXS: ) was trading around 6.66 against the
dollar on Monday, falling from its post-revaluation high of
6.6404 hit shortly before the interest rate rise, China’s first
since December 2007. [ID:nSGE69I0HU]

The People’s Bank of CHina (PBOC) has used weaker
mid-points since the rate increase as a way to ward off more
inflows of speculative capital.

However, many China-based dealers still widely expect the
PBOC to let the yuan resume appreciating later this week, and
see it climbing to around 6.60 against the dollar by late
November.

Beijing typically loosens its tight grip on the yuan as a
goodwill gesture ahead of political events that either directly
or indirectly apply pressure on China for more yuan
appreciation.

There will be a slew of such events in November.

U.S. voters go to the polls on Nov 2 in mid-term elections,
the Senate will vote on a House-approved bill pushing China to
let the yuan rise and the Treasury Department is expected to
publish a delayed twice-yearly report on currency practices of
its trade partners, which has the potential to name China a
currency manipulator.

Also, the Group of 20 leaders of major developed and
emerging markets will hold a summit in Seoul on Nov 11-12.

WHY WILL YUAN APPRECIATION PAUSE AFTER NOVEMBER?

China has its own domestic reasons to limit yuan strength,
including protecting its exporters and keeping unemployment
low.

If the yuan rises to 6.60 by late November, it will have
appreciated 3.4 percent since China abolished a nearly two-year
peg of the yuan to the dollar on June 19, right before the last
summit of the G20 leaders.

China’s many textile and garment producers, the country’s
largest single exporting industry and also its most labour
intensive, typically have a profit margin of only a few
percentage points. Officials have said a 3-percent yuan rise
will exert heavy pressure on some exporters.

Many Chinese officials and economists disagree with Western
yuan policy critics on whether or by how much the yuan is
undervalued.

The officials also argue the currency of a country with a
per capital GDP less than one-tenth of the United States cannot
be valued by the same standard. [ID:nTOE69L08E]

The difference of yuan traded in Hong Kong compared with
mainland China reached a record 0.17 yuan last week, but that
had to do with a lack of yuan in Hong Kong and regulatory
hurdles, rather than expectations of where the yuan should be
trading.

IS IT TIME TO TAKE PROFITS ON NDFS?

Offshore, benchmark one-year dollar/yuan non-deliverable
forwards (NDFs) (CNY1YNDFOR=: ) fell to 6.4330 on Monday from
Friday’s close of 6.4575, with their implied yuan appreciation
in a year’s time rising to 3.73 percent from 3.39 percent.

In the aftermath of the G20 meeting of finance ministers
over the weekend, which traders interpreted as a green light to
buy Asian currencies, it may still be prudent to bet on
sustained yuan appreciation against the dollar in the long
term. [ID:nTOE69M004]

With so much uncertainty about what China intends to do
with the yuan in the shorter term, trading volumes in NDFs have
gradually moved to the far end of the curve from the short end,
with one-year NDFs the most actively traded since around July.

A decline to 6.40 or below may spark some profit taking
that would test the patience of some traders who expect the
one-year NDFs to drop to 6.25-6.30 in the next three or four
months.

WHAT IMPACT WILL FUTURE RATE HIKES HAVE ON THE YUAN?

China will probably take precautions to cap the yuan’s rise
if there are more interest rate increases, although many
analysts do not see additional tightening until early 2011.

Even then, efforts to keep the yuan stable after rate hikes
will probably be temporary, because China has maintained its
stated policy of gradual currency reform.

External pressure, though, will from time to time compel
China to let the yuan appreciate more consistently against the
dollar.

The offshore yuan market in Hong Kong remains small and is
likely to track spot yuan movements in the foreseeable future.
(For daily yuan market reports, please click on [CNY/])
(Editing by Jacqueline Wong)

Q+A-Will China’s yuan strengthen much more this year?