With the yuan-dollar exchange rate remaining almost the same for 16 consecutive months, the Chinese government is under increasing pressure to revaluel the yuan.

Due to the pressure to appreciate the yuan against the US dollar, anticipation that the value of the yuan will rise is increasing.

On Oct 13, the yuan-US dollar exchange rate was 6.82 yuan, hitting a five-month high. After the Chinese government started to reform the renminbi exchange rate mechanism, the yuan appreciated over 15 percent against the dollar from July 2005 to July 2008.

In July 2008, the exchange rate for the dollar was 6.9 yuan, and ranged from 6.80 to 6.88 yuan for the following 16 months.

With heightened expectations about an appreciation, the one-year dollar-yuan non-deliverable forward (NDF) recorded a 14-month high of 6.65 yuan in October 2009.

The Chinese government aggressively responded to a possible appreciation and increased the interest rate of foreign currency deposits in September at four major banks: Industrial and Commercial Bank, Agricultural Bank of China, Bank of China and China Construction Bank.

From Oct 7 to Oct 22, the Hong Kong financial authorities injected HK$58.5 billion into the market to prevent a massive inflow of the dollar.

However, in spite of the efforts by the Chinese financial authorities to control the yuan-dollar exchange rate, there is still a possibility that the yuan will appreciate.

Rising expectations

With changes in the external environment, there is a strong belief that the yuan will increase in value.

Recent dollar weakness is one of the direct causes for this prediction. The dollar maintained a stable status as the global currency during the pre-financial crisis period. However, post-crisis, the value of the dollar has continued to decline.

As the status of the dollar continues to contract significantly compared with other currencies, the value of the yuan has also fluctuated.

In February, the yuan depreciated along with the dollar and in September the depreciation rate reached 8 percent. With the rising tendency for protectionism and increasing trade friction, the appreciation of the yuan emerged as a key issue for resolving trade issues.

A meeting of G7 finance ministers and Central Bank governors held in October, pointed out that a stronger yuan will promote balanced growth of the global economy.

US manufacturers and trade unions urged US President Barack Obama to resolve trade imbalances with China, as he had promised in his election campaign.

On Sept 11, the United States announced that it would impose punitive tariffs on Chinese tires for three years.

On Sept 24, the European Union decided to impose anti-dumping duties of 39.2 percent on Chinese steel and 30 percent on Chinese aluminum for five years.

On Oct 6, the European Union agreed to levy anti-dumping duties from 17.7 percent to 39.2 percent, saying that Chinese steel imports had a negative impact on EU industries.

On Oct 7, the US Commerce Department announced that it would launch an anti-dumping investigation of Chinese steel and pipeline imports. Improved trade and foreign exchange conditions in China have been a contributing factor to the growing expectations of a stronger yuan.

As the value of the yuan increased against the dollar along with the recovery of the Chinese economy, foreign institutional investors purchased the yuan and sold the dollar.

China kept its currency stable against the dollar to overcome the financial crisis. Now that China's economy has rebounded, such policies are no longer acceptable.

In September, exports and imports decreased month-on-month by 8.2 percent and 13.5 percent, respectively. The increasing number of transactions by companies using the yuan has also fueled expectations.

The value of the yuan could edge up in the short term, but the chance that its value will increase significantly is slim.

The value of the yuan will be decided depending on the value of the dollar, transactions by companies, and based on whether investors increase their investment in the dollar. Even though the Chinese economy is improving, time is needed for the economy to fully recover.

In particular, uncertain prospects for export recovery make it hard for the yuan to appreciate greatly. As the appreciation of the yuan carries the possibility of inflation, there are concerns of a possible inflow of hot money. The appreciation of the yuan could result in excess liquidity, asset bubbles and inflationary pressures.

The author is a researcher with Samsung Economic Research Institute (China). The views expressed here are his own.

(China Daily 11/30/2009 page2)