China to allow more exchange rate flexibility

US President Barack Obama welcomed China’s announcement today that it will allow a more flexible exchange rate for its currency, saying it would help protect the economic recovery.

US President Barack Obama welcomed China’s announcement today that it will allow a more flexible exchange rate for its currency, saying it would help protect the economic recovery.

The announcement by China’s central bank suggested a possible break from the yuan’s two-year peg to the US dollar – a source of friction between the two countries – but ruled out any large-scale appreciation.

The People’s Bank of China mentioned no specific policy changes, though markets will be watched closely on Monday for the effects of the announcement.

Chinese officials have said all along that reforms of the yuan, also known as the renminbi, or “people’s money”, would be gradual.

“It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility,” the central bank said in a statement posted on its website.

The announcement, timed just before President Hu Jintao’s trip to the G20 summit in Toronto, Canada, follows warnings from Beijing earlier this week against making its currency policies a main focus of the meeting.

Beijing kept the yuan frozen against the dollar to help Chinese manufacturers compete amid weak global demand. It faces pressure from the US and other trading partners who contend the yuan is under-valued.

“China’s decision to increase the flexibility of its exchange rate is a constructive step that can help safeguard the recovery and contribute to a more balanced global economy,” President Obama said in a statement.

US Treasury Secretary Timothy Geithner called the move an “important step”.

“But the test will be how far and how fast they let the currency appreciate,” he said.

IMF managing director Dominique Strauss-Kahn also praised the decision, saying a stronger yuan would “help increase Chinese household income and provide the incentives necessary to reorient investment toward industries that serve the Chinese consumer”.

But the announcement is unlikely to satisfy critics in the US Congress, who argue that an undervalued Chinese currency gives China’s exporters an unfair advantage, costing millions of American jobs.

“This vague and limited statement of intentions is China’s typical response to pressure,” Senator Charles Schumer, a New York Democrat, said in a statement. “Until there is more specific information about how quickly it will let its currency appreciate and by how much, we can have no good feeling that the Chinese will start playing by the rules.”

Signs that a global economic recovery has taken hold have prompted speculation that China would begin letting the yuan resume a gradual appreciation against the US dollar that began in 2005 but was halted abruptly in 2008 as the global financial crisis took effect.

“It definitely sounds significant. They’re saying they’re going to press forward,” Stephen Green, an economist at Standard Chartered Bank in Shanghai, said of today’s statement.

“We didn’t ever think they were going to do a big one-off, so it looks like that’s not going to happen,” he said. “We’re going to see more movement around a basically stable exchange rate until the global economy is basically healthier. The proof will be in the pudding on Monday.”

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