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China widens yuan trading band

(Bloomberg)
Updated: 2007-05-19 08:36

China widened the yuan's daily trading limit against the U.S. dollar, allowing faster gains in the currency to cool the economy and cut a record trade surplus that has strained ties with the U.S. and Europe.

"Widening the band is to further improve the yuan's mechanism, but it doesn't mean the yuan will fluctuate by a lot or appreciate by a large magnitude," the People's Bank of China said in a statement in Beijing.

The yuan will be able to move as much as 0.5 percent either side of a daily fixing rate against the dollar, up from 0.3 percent, the central bank said.

The trading band against other currencies was kept at 3 percent. The People's Bank of China also raised interest rates for a fourth time in the past year and ordered banks to put aside more money as reserves.

A stronger yuan will help temper an export-led expansion that has flooded the banking system with cash, raising concerns about a stock market bubble in the world's fastest-growing major economy. The announcement came before a May 22-24 meeting in Washington between Chinese Vice-Premier Wu Yi and U.S. Treasury Secretary Henry Paulson to discuss reducing the trade imbalance.

"This is a very big move for China," said Isaac Meng, a Beijing-based economist at BNP Paribas Peregrine. "This shows the government's determination in addressing the fundamental structural problem with the Chinese economy of excess liquidity caused by an inflexible currency."

100 Yuan banknotes are seen in this file photo. [newsphoto]

Highest Close

The one-year benchmark lending rate will be raised to the highest in more than eight years at 6.57 percent from 6.39 percent, starting Saturday, the People's Bank of China said Friday on its Web site. The one-year deposit rate will be increased to 3.06 percent from 2.79 percent.

The currency had closed at the highest since China ended a link to the dollar in July 2005, rising 0.1 percent for the week to 7.6686 at 5:30 p.m. in Shanghai, according to the China Foreign Exchange Trade System. The central bank has allowed the yuan to rise 7.9 percent since the end of the fixed exchange rate.

"This is China trying to show the U.S. that China is willing and trying to act on the currency issue," said Jeffrey Tan, a treasury dealer at Maybank Shanghai.

'Use the Band'

China's trade surplus, which ballooned 74 percent last year to a record $177.5 billion, drove foreign-exchange reserves to an all-time-high of $1.2 trillion, making it difficult for the government to slow growth. The economy expanded 11.1 percent in the three months to March 31, exceeding 10 percent for a fifth quarter.

The U.S. Treasury said after the announcement that China should use the wider band to let the yuan rise faster.

"This is a useful step toward greater flexibility and an eventual float of the currency," Brookly McLaughlin, a Treasury spokeswoman, said in an interview in Potsdam, Germany. "It's important now that Chinese authorities use the wider band and allow greater currency movement within each day and over time."

Senator Jeff Bingaman, a New Mexico Democrat, said in response that it was "not enough." Bingaman is a member of the Senate Finance Committee, which has jurisdiction over currency issues.

On May 9, Democratic Representative John Dingell of Michigan, chairman of the House Energy and Commerce Committee, had said U.S. Congress was "losing patience" with China's exchange-rate policy. Paulson on May 2 said he was concerned that the yuan was rising "very slowly."

'I Applaud'

China needs to develop a more flexible exchange rate, the National Development and Reform Commission, the top planning agency, said on April 25. The central bank also said Friday it will keep improving its foreign-exchange management.

In July 2005, China ended a decade-long link to the dollar, letting the yuan move in reference to a basket of currencies including the euro, yen, British pound and South Korean won.

"The move will increase the yuan's flexibility and help companies become competitive," the People's Bank of China said in the statement.

Fund managers are heartened by China's decision to widen the currency band and raise the interest rates and reserve requirement ratio. China's benchmark CSI 300 Index, which tracks yuan-denominated A shares listed on the nation's two exchanges, jumped 85 percent this year.

"I applaud these measures," said Aaron Boesky, who manages $100 million, including Chinese shares, as chief executive officer at Marco Polo Investments Ltd. in Hong Kong. The Chinese government "is doing the right thing. We don't see a bubble" in China's stock markets. "The market's valuations are well-deserved."