Indian and Chinese banks pulling out of ailing U.S. dollar


By Yumi Kuramitsu
Bloomberg News Service
Monday, March 7, 2005

HONG KONG -- China plans to keep its currency pegged to the U.S.
dollar for "a relatively long time" as the country faces less
pressure to let the currency rise because the government is taking
measures to slow inflation.

China won't let the yuan float freely, Guo Shuqing, head of the
State Administration of Foreign Exchange, said in Beijing on March
5. China's Premier Wen Jiabao on the same day said he would keep the
yuan at a "stable" rate.

"It must be a managed floating exchange rate," Guo said. "That
policy will not change for a relatively long time."

China's consumer prices rose in January at their slowest pace in
more than a year -- 1.9 percent on year -- down from a seven-year
high of 5.3 percent in August, reducing the need for a stronger

"The inflation pressure is off, so for that reason there is no
urgency" to let the currency rise, said Uwe Parpart, senior market
strategist in Hong Kong at Bank of America Corp. A change in the
currency system "may happen later rather than earlier because there
is really no great hurry now."

Bank of America said on Feb. 23 it pushed back its forecast for when
China will let the yuan rise against the dollar to the second half
of 2005 from the first quarter.

China plans to slow growth in the world's fastest-growing major
economy to 8 percent this year from an eight-year high of 9.5
percent in 2004, Wen told the National People's Congress in Beijing
in his annual report on Saturday. Wen said his focus will be on
keeping inflation at 4 percent this year, from a peak of 5.3 percent
last year.

China's economy almost trebled in size in the past decade and its
demand for raw materials helped fuel a surge in commodities prices.
Crude oil prices have increased almost 24 percent this year
following a 34 percent jump in 2004, and copper prices added 3
percent after a 37 percent gain last year.

Government reports showed China's industrial production rose in
January at the slowest pace since December 2001 and fixed- asset
investment rose 25.8 percent last year, slowing from a gain of 27.7
percent in 2003.

Keeping the yuan's peg may mean rising import prices will revive
inflationary pressure amid higher commodities prices, including oil,
that are priced in dollars. Allowing a gain in the yuan may lower
import prices and damp export-led growth by raising the cost of
Chinese goods overseas.

China has fixed its currency, also called the renminbi, at 8.277
against the dollar since 1995, a system the government refers to as
a managed floating exchange rate, leading to criticism from U.S.
companies, including steelmaker Nucor Corp., that the peg is keeping
the prices of Chinese goods artificially low.

The People's Bank of China on Oct. 29 increased interest rates for
the first time in nine years to help slow growth. The government
also last year restricted lending to industries such as steel, autos
and real estate to help ease power shortages and damp inflation.

The bank maintains the view China may alter its currency regime
sometime this year, more probably in the latter part of 2005,
according to the report. Jen confirmed the contents of the report
via e-mail on March 1.

Investors have been betting on a change in China's currency since
2002, according to trading of non-deliverable forward contracts. The
yuan would rise to 7.9545 against the dollar in a year if freely
traded, the contracts showed at 5:09 p.m. in Hong Kong on March 4.
The forwards give investors the chance to wager on the future value
of a currency that isn't fully convertible or hedge investments
denominated in it.

A two-tier system using one currency for internal purchases and
another for international trade was introduced in 1980 and scrapped
in 1994, when the yuan was established.

Permitting gains in the yuan would mitigate the impact of increasing
foreign investment that has spurred money supply.

Foreign direct investment in China rose about 14 percent to a record
$60.6 billion in 2004, the Ministry of Commerce reported on Jan. 13.
China in 2003 attracted $53 billion in investment from abroad,
surpassing the U.S. for the first time as the biggest recipient. M2,
which includes cash and all deposits, expanded 14.1 percent in
December from a year earlier to a record 25.8 trillion yuan ($3.1
trillion), the central bank said on Feb. 17.

China's central bank has to buy dollars that flow into the economy
to maintain the yuan's fixed exchange rate, adding yuan to the
economy and diluting the impact of state lending curbs.

The central bank spent 1.6 trillion yuan buying foreign currency in
2004 to maintain the peg, a 41 percent increase from the previous
year, the bank said on Feb. 28.

"The central bank faces comparatively large pressure in the
management of money flows and currency controls," the People's Bank
of China said in a report on its Web site.

Surging exports, investment from abroad and speculative inflows of
capital betting on a yuan revaluation pushed China's foreign
reserves to a record $610 billion last year, the world's second-
biggest after Japan.

China should move to a freer exchange rate system to help improve
the government's ability to manage the economy, Paul Speltz, the
Treasury's emissary to China, said on Feb. 28.

"This is in China's own interest," Speltz said. "It will give China
greater control over domestic money supply."


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