China’s yuan set for more international role

HONG KONG (MarketWatch) � Big changes could be underway for China�s currency this year, as Beijing moves forward with plans to free up its forex rules and increase the use of the yuan in its trade with the world.

Unnerved by the financial crisis in the euro zone, Chinese policy makers are contemplating a new approach that won�t be immediately obvious in the currency charts, according to one analyst.

Economist Intelligence Unit�s Asia economist Duncan Innes-Ker in London said the consensus in Beijing is tilting towards efforts to accelerate the internationalization of the yuan � a reform that would also entail a gradual appreciation of the Chinese currency and would bring forward the eventual end of China�s managed foreign-exchange regime.

�What you saw last year was the Chinese trying to diversify their foreign-exchange reserves [which are] being savaged by what�s going on in the euro area,� said Innes-Ker.

The shift seems to have garnered momentum around the middle of 2011, he said, with an expanded international role for the yuan backed by the Ministry of Finance and the People�s Bank of China, and with the Ministry of Commerce � which has traditionally supported a weak currency to help exporters � apparently losing clout.

Modest appreciation

However, don�t expect a big rise in the yuan this year, as China is likely to opt for a gradual appreciation of its currency over time, with an expected annual gain of 2.7% against the U.S. dollar in 2012, according to the Economist Intelligence Unit.

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�We are expecting continued moderate appreciation, but nothing dramatic,� Innes-Ker said.

The Chinese currency rose 4.3% against the dollar in 2011, and is up about 23% since China first ended its formal currency peg to the U.S. currency in July 2005.

Allowing the Chinese currency to rise too fast would likely bankrupt patches of the manufacturing sector, much of which survives on �razor-thin margins,� said Innes-Ker.

Other analysts agree that China�s currency will continue to appreciate, even amid the deteriorating global export outlook, with internal Chinese politics also playing a role.

RBC Capital Markets� Brian Jackson in Hong Kong said political considerations were likely to weigh heavily on the minds of Chinese authorities during a year that includes a U.S. presidential election and changes in China�s top leadership.

The Chinese Communist Party is due to meet this year to begin the transition that will replace President Hu Jintao and Premier Wen Jiabao, both of whose terms expire in 2013, along with other top officials. See report on Chinese leadership change.

�I think there�s going to be a requirement to keep currency policy on an even keel, [as] they don�t want to rock the boat,� Jackson said, adding the dollar will likely ease to 6.10 yuan by the end of the year, down from its current level around 6.33 yuan.

He said analysts were unusually divided over how much the Chinese currency would appreciate this year, even as most were forecasting gains.