What is the issue with yuan?
China and the US have been trading charges over the exchange rate of the yuan. The US has accused the country of keeping the yuan undervalued, which, it argues, is the primary reason for the high trade deficit it runs with the country. The undervalued yuan, many experts have said, is also the reason for global imbalances -- deficits in the developed world and surplus in China.
What exactly has China decided?
China's central bank, the People's Bank of China (PBC) said on Saturday," In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility." "It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility," the PBC added. The PBC also indicated that the peg to the dollar could be abandoned and instead the renminbi will be benchmarked to a basket of currencies.
What are the implications of China's move?
China's announcement is being seen as intent to allow a gradual appreciation of the yuan, largely against the dollar. Though the PBC retained the existing trading band for the currency at +/- 0.5% per day, it is expected that the
renminbi, another name for China's currency, will appreciate against the dollar over a period. Essentially, the tight trading band will ensure that there is no volatile adjustment in the value of the renminbi to the perceived market price of the currency.
How will the move impact the global economy?
Conceptually, a stronger yuan should erode competitiveness of China's exports, making it easier for other countries to compete. This should help address the global trade imbalances -- China's surplus against deficits of others. However, to the extent the appreciation is expected to be very gradual because of the tight trading bands, there is unlikely to be a sudden change in comparative trade equation or capital flows. In fact, the People's Bank of China effectively ruled out large scale appreciation. It said, "With the BOP account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist." However, the move will help reduce the tension between the US and China. More importantly, it sends a strong signal about the state of the Chinese economy and the sustainability of the global recovery.
