CHINA YUAN REVALUATION PROSPECTS HEAT UP

• JANUARY 14, 2010, 12:01 P.M. ET
• Wall Street Journal
China Yuan Revaluation Prospects Heat Up

LONDON -- China could throw a major surprise into the currency markets this year, as a revaluation of the yuan may be more likely than investors had assumed.

Most economists have given up on China snapping the yuan's peg to the dollar, which has persisted since the middle of 2008, as the emerging economic superpower has repeatedly rejected the idea.

However, the picture has changed somewhat this week, as the Chinese authorities have made it clear that they are determined to tackle early signs of overheating in the economy.

Now, some heavyweight economists are starting to take the idea that currency strength could be a useful tool in that fight more seriously.

Speculation started to gather Tuesday, when the People's Bank of China slapped tougher reserve requirements on its banks to pinch rampant lending, prompting market watchers to mull the chances of a straightforward interest rate rise.

China had already boosted interbank lending rates.

Thursday, the strategy team at Goldman Sachs reacted by saying "we now expect the Chinese authorities to allow the yuan to resume its appreciation path."

The bank, whose views are closely watched by investors, made the new call partly in response to surprisingly upbeat Chinese trade data for December, which showed an 18% rise in exports compared to the same month in 2008.

Goldman Sachs now expects the authorities to unleash a range of measures to tackle inflation, which it sees running at an average rate of 3.5% this year, compared to its more modest expectation of 2.4% earlier. The chances of a revaluation will build further if the steps undertaken so far do not have the desired effect, analysts at French bank BNP Paribas agreed.

Goldman Sachs said it's unsure when the yuan could start climbing, but it expects to see a 5% appreciation in the currency from the current dollar level of CNY6.8270over the next 12 months. Judging from the forwards market, the rest of the market expects a slower 3.2% climb.

Stephen Jen, a currencies investor at hedge fund BlueGold Capital in London, said that with Chinese inflation accelerating, and threatening to breach the PBOC's 2% target, he expects the yuan to be refloated "as early as March or April" -- although that's a view he has held for some time.

A yuan revaluation would likely be China's final option in fighting inflation, not least as it would reward many of the speculators that the authorities have been trying to deflect.

The move would be a major shock to the currencies markets. Policymakers and politicians around the world have been calling for a shift for months, as China's efforts to keep the yuan relatively weak boosts its exports at the expense of those from other countries.

Just this week, incoming European Union trade commissioner Karel De Gucht described an undervalued yuan as "a major problem." Chinese officials are unfazed, however. After De Gucht's remarks, China's foreign ministry spokesman Jiang Yu again defended Beijing's currency policy, saying a stable yuan is important for China and for the world's development.

The likely reaction in the currencies market is tough to predict. Australia's heavy exports to China make the Australian dollar very sensitive to Chinese tightening. Indeed, the so-called Aussie wobbled as China toughened up capital requirements Tuesday.

Other Asian currencies, which are currently lightly managed to prevent them strengthening too far ahead of the yuan, would likely be allowed to climb.

The U.S. dollar could fall if a revaluation removed the need for China to absorb such huge flows of dollars to hold the yuan steady.

More likely, though, as BNP Paribas stressed this week, the dollar would broadly climb as China would have less need to convert its dollar hoard into other currencies. The euro and other major currencies would probably fall as the yuan assumes more of the burden for dollar weakness.

The dollar could also climb if a Chinese revaluation spooked investors and made them nervous about global recovery prospects.

http://india.wsj.com/home-page