China Severs Its Currency's Link to Dollar
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China Severs Its Currency's Link to Dollar

Associated Press | July 21, 2005
By STEPHANIE HOO

China dropped its politically volatile policy of linking its currency to the U.S. dollar on Thursday, adopting a more flexible system based on a basket of foreign currencies that could push up the price of Chinese exports to the United States and Europe.

The government also strengthened the state-set exchange rate to 8.11 yuan to the dollar — from 8.277 yuan, where it had been fixed for more than a decade — in a surprise announcement on state television's evening news. That raised the value of one yuan by about one-quarter of one U.S. cent to 12.33 cents.

China had been under pressure for years from its trading partners to let the value of the yuan float or at least trade at a stronger rate and some U.S. lawmakers had threatened to impose retaliatory tariffs if China didn't adjust its currency scheme. The United States and others had said the communist nation undervalued the yuan by up to 40 percent, giving Chinese exporters an unfair price advantage.

The Bush administration on Thursday praised China's decision but said it planned to monitor the country's implementation of the new arrangement.

"I welcome China's announcement today that it is adopting a more flexible exchange rate regime," Treasury Secretary John Snow said in a statement. "As we have said, reform of China's currency regime is important for China and the international financial system."

The White House also hailed the announcement. "We are encouraged by China's announcement today that they are adopting a more flexible market-based currency system," Bush spokesman Scott McClellan said.

The new system puts tight daily limits on changes in the yuan's value but could allow it to change substantially over time.

Beginning Friday, the yuan will be limited to moving each day within a 0.3 percent band against a collection of foreign currencies, the government said. But the officially announced price at the end of each day will become the midpoint of trading for the next day, which could let the yuan edge up incrementally.

"This is the start of a gradual appreciation process," said Frank Gong, managing director of JPMorgan Chase & Co. in Hong Kong. "It will help balance Chinese trade flows. Export volumes will come down. Import volumes will pick up. It will help reduce trade tensions."

The move could nonetheless help Chinese exporters' profits by cutting costs for imported oil, iron ore and other raw materials whose prices have been surging in dollar terms, Gong said.

And it could encourage domestic spending, making China's economic growth less dependent on exports, Gong said.

"China is finally doing the right thing," he said.

The U.S. dollar dropped against the Japanese yen — an Asian benchmark — on the news, falling to 110 yen from about 112 yen. U.S. treasuries fell alongside the dollar as investors feared the possible inflationary effect of higher import prices in the U.S. The yield on the 10-year Treasury note rose to 4.22 percent from 4.18 percent late Wednesday.

Japan, one of China's trade partners that had urged it to let the yuan float, welcomed China's decision.

"We hope that this decision will lead to more balanced and stable economic growth for China," the Bank of Japan's international department said in a statement. "We highly value this move."

In South Korea, government officials said they didn't expect it to have a big impact on the nation's economy, the third largest in Asia following Japan and China.

"Yuan's revaluation was only a matter of timing; we knew it was going to happen," said Rhee Yeung-kyun, assistant governor of Bank of Korea. "I don't expect much effect the Korean won as the won has been sufficiently been appreciated."

Philippine central bank Gov. Amando Tetangco said the move was expected to strengthen regional currencies, including the Philippine peso.

The governor of the Bank of Thailand held an urgent meeting with other senior central bank officials as soon as they learned of the news, but no details of their meeting were immediately available.

Yuji Kameoka, currency analyst at Daiwa Institute of Research in Tokyo, said China's decision made sense.

"It was good timing because the dollar has been strengthening lately," he said. "It would have been very difficult to do if the dollar had stayed weak."

Hong Kong, a key Chinese banking center that has its own currency, will keep its currency pegged to the U.S. dollar, the city's acting financial secretary Stephen Ip said.

Malaysia simultaneously announced it was dropping its own policy that tied its currency, the ringgit, to the U.S. dollar and would adopt a currency basket arrangement similar to China's.

Chinese leaders have said for years that they eventually would let the yuan trade freely on world markets. But they said any decision would be based on China's economic needs, not foreign pressure.

Chinese officials said any abrupt change in its currency system would cause turmoil, hurting its fragile banks and financial industries.

The central bank's news department said there no plans for a news conference to clarify the new policy.

 

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