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November 25, 2005


Yuan Appreciation Watch

From this morning's Wall Street Journal Online (subscription required):

China's central bank on Friday executed a deal in the domestic foreign-exchange market in what traders interpreted as a signal that a mild appreciation in its currency will be tolerated over the next year.

The People's Bank of China's "swap" with state banks allows it to buy $6 billion in 12 months at an exchange rate of 7.85 yuan. To make the deal attractive for the central bank, the yuan would need to rise at least 2.9% from current levels, not including interest. Traders said the central bank could therefore be trying to telegraph its expectations that the yuan will edge higher over the coming year.

The swap transaction was the first ever conducted by China's central bank and marks the latest advancement in the system's market orientation. More swaps could follow in the next few weeks and provide further clues of the central bank's thinking.

Here is the "however" part:

While Friday's swap transaction could signal there will be more flexibility in the currency in coming months, traders also said the central bank just as easily could have been trying to temper enthusiasm for a stronger yuan. Before the swap with what Dow Jones Newswires said were 10 banks, foreign exchange derivatives markets were already pricing in expectations the yuan would rise about 4% versus the U.S. dollar over the course of the year. Other non-deliverable forward derivatives contracts traded in Singapore and elsewhere outside China quickly matched the narrow appreciation level suggested by the swap transaction.

Meanwhile the evolution of the financial markets continues:

In another move that suggested China intends to introduce additional flexibility into the currency-exchange-rate system, the central bank said late Thursday it will tap market makers for dollar-yuan trading in 2006.

A market maker system could be a step toward relaxing the direct control China's central bank maintains over the yuan's value. Analysts say active participation by market-making firms could eventually replace the buying and selling of yuan often attributed to the People's Bank of China. Still, until China's yuan is fully convertible, the central bank would be expected to retain indirect control over the currency exchange rate by requiring qualified markets to follow certain instructions that would limit foreign-exchange volatility.

Note: If you are unfamiliar with currency swaps, you can find several simple definitions here, and a more extensive discussion here.

November 25, 2005 in Asia , Exchange Rates and the Dollar | Permalink

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Listed below are links to blogs that reference Yuan Appreciation Watch :

» Daily linklets 28th November from Simon World
A bumper Monday edition: Hong Kongs smog claims the Kitty Hawk. Nude chat is almost not illegal in China. The general fallacy in Western analysis of China. Can Bush solve Chinas Yasukuni problem? Maybe its Japans Yasukuni problem. I... [Read More]

Tracked on Nov 28, 2005 2:31:50 AM

» Why the RMB USD swap is set at 7.85 from sun bin
So let's try to understand whether it is fair deal to the banks, or if not who is going to be benefited if RMB appreciates (or depreciates). [Read More]

Tracked on Nov 29, 2005 4:28:39 PM

Comments

Andy Xie also has some ineteresting observations on how changes in the value of the Yen could affect yuan expectations, and what this might mean for 'hot money'. He makes the point that with capital controls, and exports at a level of 70% of GDP, the easiest way of 'getting round' the controls is over- and under-invoicing. This means - given the volume of exports and the difficulty of control - that money can leave very quickly, and looking at the way people are leaving Harbin right now, I can't help thinking about your Higgins and Humpage link.

http://www.morganstanley.com/GEFdata/digests/20051125-fri.html#anchor1

Takehiro Sato, commenting on the Japanese price index says this:

"The wild cards are oil prices and the (US) dollar/yen rate. Our scenario could crumble if these prove stronger than we expect. In truth, there is massive uncertainty about where prices will be a year from now."

When he talks of massive uncertainty, and you say "Perhaps the uncertainty will lift sooner than later.", I can't help thinking that maybe what we really need is a level of uncertainty index :).

Posted by: Edward Hugh | November 25, 2005 at 09:08 AM

PBoC has entered into similar contracts with state banks before, although it was an option with a different strike price.

http://sun-bin.blogspot.com/2005/08/how-much-would-rmbusd-rate-drift-ii.html

my gut feeling is that the change in exchange rate implied by such transaction will be just short of making the NDF speculation profitable, for obvious reason.

http://sun-bin.blogspot.com/2005/07/how-much-would-rmb-peg-drift.html

Posted by: sun bin | November 28, 2005 at 05:13 AM

somehow trackback doesn't work. :(

i finally did the swap calculation. 7.85 just reflected the difference in interest rates

http://sun-bin.blogspot.com/2005/11/why-rmb-usd-swap-is-set-at-785.html

Posted by: sun bin | November 29, 2005 at 03:19 PM

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