China: Appreciation pressure intensifies

• Political pressure on China from within Asia has increased with the finance ministers from both Indonesia and Singapore yesterday calling for yuan appreciation, and the APEC finance ministers today pledging to embrace flexible exchange rates. The Peoples Bank of China in its quarterly report yesterday prepared the ground for a change in China’s exchange rate policy.

• With China’s exports recovering, the leadership is sounding more confident about growth, and with political pressure intensifying, we believe the conditions are ripe for a change in China’s exchange rate policy. We still expect the gradual appreciation of the yuan to be resumed by mid 2010. However, the risk that it could start earlier has increased. A major one-off revaluation cannot be ruled out, while a complete float is highly unlikely.

Political pressure on China within Asia increasing

The political pressure on China to let the yuan appreciate is intensifying. It is becoming increasingly clear that Barack Obama’s trip to Asia in the coming week will be used to argue the case for an appreciation of the yuan. US Treasury Secretary, Timothy Geithner, is currently preparing the ground for meetings with Asian finance ministers. The most important development is that other Asian countries are becoming increasingly vocal in their demand for a yuan appreciation. In today’s edition of Wall Street Journal, Geithner, the Indonesian Finance Minister, Sri Mulyani Indrawati, and Singapore’s Finance Minister are together calling for “market-oriented exchange rates in line with economic fundamentals”, please see Wall Street Journal. This is the polite way to ask for a yuan appreciation. In addition, the final communiqué from the APEC finance ministers meeting held today in Singapore included a call for “flexible exchange rates”. The APEC group includes 21 countries in the Asian-Pacific Region including the US, Japan, China Australia, India and the ASEAN countries.

That the call for yuan appreciation is gaining support within Asia is an extremely important development. The multilateral cooperation within Asia has been a major focus in Chinese foreign policy in recent times, and the cooperation with the ASEAN countries has been a cornerstone in this regard. Two of the most important ASEAN countries are calling for an appreciation of the yuan – this will be noticed in China. The escalating call for yuan appreciation among Asian countries reflects the fact that the dollar scarcity during the peak of the global financial crisis has reverted into a flood of USD liquidity. Across the board, Asian central banks are intervening to stem currency appreciation, and in October the FX reserves for Asian countries excluding China and Japan reached a new record high. Earlier this week, Taiwan was the first Asian country to introduce capital controls to stem capital inflows. The cost of this massive currency intervention is a major boost to liquidity.