Slower yuan appreciation due to mainland economy slowdown

The yuan depreciated around 1 percent year-to-date, hampered by the slowing domestic economy and the eurozone debt crisis. However, in anticipation of the launch of more fiscal and monetary stimulus packages by the country to spur recovery momentum, I believe the downward pressure on the currency will ease and look for the currency to rise 0-1 percent by end-2012.

Slower yuan appreciation is expected in the light of headwinds for economic growth. The weak economic numbers in the first half of 2012 have prompted the nation’s policy makers to shift their focus from containing inflation to reviving economic growth. Should the economic growth continue to slow down, I believe it will cap the yuan’s strength, although this should help alleviate some disinflationary pressure and give the export sector some relief.

Meanwhile, the ongoing euro zone debt crisis is also likely to cap the upside of the yuan in the short term. The intensified sovereign debt crisis in Europe has boosted demand for safe-heaven assets, such as US treasury bonds. With the stronger US dollar supported by a plunge in the euro and a threat of persistent economic instability globally, the Chinese currency is likely to see limited upside in the second half of the year.

However, the weakening euro makes room for greater exchange rate flexibility for the yuan. I believe the decline in the status of the euro as a reserve currency due to the sovereign debt crisis will make room for China to enhance the yuan’s role in the global economy. As such, the country is expected to accelerate its exchange rate reform.

In the long run, the currency is likely to maintain an uptrend, driven by the internationalization process. As part of its effort to step up yuan liberalization, the People’s Bank of China has widened the trading band of the currency, thus allowing direct currency trading between China and Japan and taking steps to liberalize interest rates. The market is now widely expecting a rise in the daily conversion quota of yuan and more yuan-denominated product launches in the Hong Kong offshore yuan market, following President Hu Jintao’s scheduled visit to Hong Kong in early July to mark the 15th anniversary of the territory’s return to Chinese rule. The above-mentioned moves will reinforce China’s further opening of its forex market and improve the fundamental value of yuan through encouraging more organic market growth and diversifying cross-border channels for trade and investment.

The author is an associate director and economist at CCBI. The opinions expressed here are entirely his own.