Analysts play down yuan revaluation talk

Speculation has increased in recent weeks after Dallas Federal Reserve president Robert McTeer said earlier this month that China should reconsider its dollar peg as its importance in global trade grows. A research report by Goldman Sachs economists further fuelled the speculation, saying that to instigate structural reforms and safeguard financial stability, China should adopt a more flexible exchange rate system.

Yuan implied options volatilities -- which measure expected future spot movements -- rose in the wake of the speculation, but analysts remain convinced that the peg would remain in place until at least 2004.

In research published last week, Barclays Capital said China's economy was slowing and that "softer growth and an expected return of RPI [retail price index] and CPI [consumer price index] deflation will likely reinforce Beijing's aversion to a CNY revaluation".

The bank said a strong non-state sector remained key to the government's efforts at slowing the rise in unemployment by absorbing under-employed state workers -- unemployment in China reached a 23-year high of 4.0% in 2002. Consequently, the growth benefits of a "hyper competitive exchange rate would likely be preserved unless a revaluation became a required response to trade fractions", the research said.

However, Pieter van der Schaft, director of economic research at Barclays Capital, told FX Week it was very hard to predict exactly when the peg would be relaxed. "It depends on the strength of the US dollar, US-China trade relations and global economic growth, as well as how well the Chinese authorities are able to control the liquidity overhang within China," he said. "I would think a revaluation is possible within two to three years, but it's very difficult to say."

Eddie Wong, ABN Amro Asian chief strategist in Hong Kong, agrees the peg will last at least until next year. "The Chinese government has a new state council and they are still struggling to deal with Sars. They need some time to settle down before they can make any move," he said. China's latest president, Hu Jintao, came to power in March this year.

Claudio Piron, head of foreign exchange strategy at Standard Chartered Bank in Singapore, believes the peg will not be relaxed for at least three years. "First there needs to be some kind of capital account liberalisation and the difficulty with that is they still need to clean up the banking sector in China, and that will take a number of years to occur," he said. "That's why we look at the CNY peg revaluation being a three to five year horizon issue rather than anything within the year or next two years."