Chinese walker

The noticeable weakening of the spot Chinese yuan (CNY) against the US dollar (USD) in the first few days of December fanned expectations that the Mainland authorities would reverse their policy of CNY appreciation against the greenback. A marked slowdown in domestic and external demand since 3Q 2008 has put the authorities under great pressure to devalue the CNY as a means to stimulating exports.

But devaluing the CNY would be a difficult choice for the Mainland. With export growth responding more to changes in overseas demand than exchange rates, the benefit from devaluing the CNY may be marginal. The Mainland is also under constant pressure from the US and Europe governments to strengthen the CNY as a means to eliminating the huge trade surplus of the country with the two regions. Moreover, a change of market expectation from appreciation to depreciation of the CNY could also trigger sudden capital outflow, which could destabilise the domestic economy.

It is most probable that the Mainland would stabilise the CNY at around 7.0 against the USD in the coming year, and simultaneously widen the daily trading limit to +/-3.0% from the present +/-0.5%, in line with the trading bands for CNY rates versus non-USD currencies, to increase flexibility of the exchange rate.

The CNY closed 0.7% weaker at 6.8848 against the USD on the spot market on 1 December, the biggest one-day loss for the CNY since July 2005 when mainland China began pegging its currency to a basket of currencies. The rate continued to trade near the 6.88 level in the following six days.

Not only did the CNY depreciate markedly against the USD on December 1, it also touched the upper bound of the +/-0.5% daily floating limit for the first time. The upper limit was hit again on the two subsequent days. The daily band is the permitted trading range of the spot CNY rate against the USD compared with the mid-rate set by the People Bank of China (PBOC) each morning. The band for the CNY rate against the USD was widened from +/-0.3% to +/-0.5% in May 2007.

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