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Sat, Jul 23, 2005 - Page 12 News List

Contents of currency basket to remain secret

FLEXIBILITYTo outwit speculators, the country's central bank is likely to protect its still rickety financial system by drawing a veil over the yuan's weighting basis

AFP , SHANGHAI

A woman is framed by a display of imported shoes in a shop in Singapore yesterday. China's decision to lift the yuan's peg to the US dollar could make its exports more expensive over time.

PHOTO: AP

A basket of the dollar, euro and yen likely forms the backbone of China's new currency regime, but its composition and weighting will likely remain secret as the central bank seeks to outwit speculators, analysts say.

China's decision to revalue the yuan on Thursday, largely seen as a token gesture to appease international criticism that it was undervalued, was a carefully calculated move meant to protect its still developing economy, they said.

By abolishing the decade-old peg to the dollar in favor of an unknown currency-basket system, Beijing aims to protect its still rickety financial system against the forces of international speculation.

"Definitely it will not be announced because then it would be too easy for speculators to calculate [the weightings,]" said Yi Xianrong, economist at the Chinese Academy of Social Sciences.

Speculation is a powerful force in today's integrated world economy and sudden, sharp attacks on countries' unit can bring governments to their knees, as happened during the 1997 Asian financial crisis.

"What they want to avoid is a hard target for speculators to attack," said Todd Lee, managing director at research firm Global Insight.

Analysts said the euro, yen and dollar should make up the bulk of China's new basket of currencies, with the units of smaller Asian trading partners such as the Singapore dollar possibly also included.

The main trading band, which allows the yuan to move 0.3 percent either side of a fixed mid-point, has been left unchanged, which theoretically means the currency could move by that maximum on a daily basis fairly quickly to what the market deems fair value.

"The People's Bank of China will make adjustment of the exchange rate band when necessary according to market development as well as the economic and financial situation," the central bank said in its announcement on Thursday.

Yesterday it said the yuan would be allowed to trade up or down 1.5 percent on either side of a mid-point against non-US dollar currencies in the interbank market.

Many analysts believe that the yuan, set on Thursday at a starting point of 8.11 yuan compared to the previous rate of 8.28, an effective revaluation of some 2 percent, still remains significantly undervalued.

But the main question now is whether China would make use of the newfound flexibility to let the yuan drift gradually higher.

Because Asian trade uses the dollar to record upwards of 65 percent of financial transactions, the currency basket is likely strongly skewed toward the US unit, said Huang Yiping (黃益平), China economist at Citigroup.

Morgan Stanley economist Andy Xie (謝國忠) added that China could afford to allow the yuan more flexibility to move against non-US currencies, given they will make up a far smaller share of the basket.

Xie said, however, that the trading range for both the dollar and non-dollar currencies remain too narrow to cope with major foreign exchange rate fluctuations.

"If the US dollar moved 10 percent, obviously the 3 percent [trading range for non-US currencies] would be insufficient," he said.

"That may create a dilemma for the renminbi [yuan]-euro exchange rate. This is a problem that is not solved yet," Xie said.

As it stands, the change still signals a fundamental shift in China's economic policy but the new system also poses inherent risk for Chinese corporations, said Wang Zhao, an economist at the National Development and Research Center of the State Council, the country's Cabinet.

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