China official: Hedge funds delay convertibility
(bloomberg.com)
Updated: 2005-07-25 14:32

China won't make its currency fully convertible for at least five years because it worries hedge funds may force the yuan to plunge, much as happened to the Korean won and Thai baht during the 1997 Asian financial crisis, said Li Deshui, a member of the central bank's monetary committee.

``There's more than $800 billion to $1 trillion of hedge funds in the world and the Chinese financial system is relatively weak,'' Li, 61, said in an interview. ``If the (yuan) becomes fully convertible it would be attacked by these hedge funds.''

China last week ended its currency's decade-old peg to the U.S. dollar, allowing the yuan, also known as the renminbi, to strengthen 2.1 percent from its previously fixed rate of about 8.3, marking the first step toward a more flexible exchange rate regime. The U.S., European Union and Japan have pressed China to abandon the yuan peg and allow the currency to strengthen to curb what they say is an unfair advantage for Chinese exporters.

A decade ago, Thailand's decision to let the baht drop triggered the start of the Asian financial crisis and a wave of devaluations of other currencies in the region and in Latin America. China was the only major developing economy to maintain the value of its currency during the crisis, earning plaudits from countries including the U.S. and Japan that had feared any such move could trigger another round of competitive devaluations.

Li, who is also commissioner of China's National Bureau of Statistics, said the state of the country's banks is a key reason why the government won't allow the yuan to become a fully tradable currency anytime soon.

'Not Good Enough'

``Over the next five years, I do not foresee the renminbi becoming fully convertible,'' Li said in Beijing on July 22. ``Our banks are not good enough and the monetary system is not quite up to international standards.''

China's banks are struggling to offload some 1.59 trillion yuan ($196 billion) in bad loans, a legacy of policy-directed lending to state-owned companies. They have also been ordered by regulators to raise their capital adequacy ratios to a minimum 8.0 percent by the end of 2006, when restrictions on foreign banks operating in China are lifted.

Bad loans as a percentage of total lending at China's banks fell to 10.15 percent at the end of June, the China Banking Regulatory Commission said on July 13. The bad-loan ratio at 208 financial institutions based in Hong Kong was 1.56 percent at the end of 2004, according to the Hong Kong Monetary Authority.

Last Defense

Economists and institutions including the International Monetary Fund have urged the world's third-largest trading nation to gradually make the yuan convertible on the so-called capital account, which would allow money to flow freely in and out of the country for investment purposes. The currency is already convertible on the current account for trade in goods.

The lack of full convertibility of the yuan is ``China's last economic and financial defense,'' Li said, adding that the government will ``not easily allow'' a change in the policy.

Chris Leung, an economist with DBS Bank in Hong Kong, said China's move to full yuan convertibility will hinge on whether the pace of the country's economic growth can be maintained.

``If the economic growth slows down, the government will have to move on at a much slower pace,'' said Leung, who wrote a note on July 20 predicting that the yuan's revaluation was imminent. ``There are way too many problems and contradictions in China's economic development that need to be solved, so I believe it must be longer than five years.''

Yuan Trading

China last week said the country's economic growth rate accelerated to 9.5 percent in the second quarter, from 9.4 percent in the previous three months, aided by a surge in the country's trade surplus.

Under the new exchange rate mechanism, the yuan will be allowed to trade within a limit of 0.3 percent either side of the yuan-dollar exchange rate published by the People's Bank of China each day. The yuan will be allowed to trade within a 1.5 percent range either side of the rate published for other currencies. The exchange rate will use a basket of currencies, the composition of which has not been disclosed, as a reference.

The currencies of China's major trading partners will be included in the basket, Li said. ``I'm not talking about just yen, euros and pounds,'' he said, declining to specify the weightings. ``You name the currency, it's in the basket.''

China's main trading partners last year in descending order of total value of trade were the European Union, the U.S., Japan, Hong Kong, the ASEAN bloc, South Korea, Taiwan, Russia, Australia and Canada, according to the country's commerce ministry Web site.

Barometer

The yuan was fixed at 8.111 against the dollar in the first trading day on Friday, and was trading at 8.1101 against the dollar at 1.04 p.m. today Beijing time, according to the Web site of the Shanghai-based Foreign Exchange Trading System.

``The U.S. dollar is no longer the only barometer of the global economic condition,'' central bank Governor Zhou Xiaochuan said in Beijing on July 23. ``The reform is aimed at sustaining the growth of China and it's not a result of negotiation with other countries.''

Before China's 2 percent revaluation, economists such as Jim O'Neill, head of global economic research at Goldman Sachs Group Inc., had said the yuan was undervalued by more than that amount.

O'Neill on May 20 said the currency was undervalued by about 10.5 percent. A study last year by Morris Goldstein of the Institute for International Economics, said the yuan was undervalued by between 15 and 25 percent.

Still, economists at the International Monetary Fund wrote in a report in January that evidence the yuan ``is substantially undervalued in terms of fundamentals is far from conclusive.'' The report was written by Eswar Prasad, Thomas Rumbaugh and Qing Wang.

(Courtesy of bloomberg.com)