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China’s hand appears to be back on the yuan tiller

An employee counts Chinese yuan notes inside a bank in Taipei February 6, 2013.

STRINGER/TAIWAN/REUTERS

Just when China's yuan was on track for a gentle climb upward, the neighbours started to weigh in with their own problems.

With the Chinese New Year looming, policy makers have been confronted by the plummeting Japanese yen, which has fallen 16.9 per cent since October as of the start of this week. Now adding to the trouble is the performance of the South Korean won, which has dropped 3.6 per cent in just under a month.

The basket of currencies on which the People's Bank of China bases the yuan's value includes the yen, and that currency's drop should have pressured the yuan into creeping upward. Instead, after hitting a record high on Jan. 14, at 6.2124 against the U.S. dollar, the yuan traded at its lowest point this year on Monday, at 6.2342.

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With the dollar/yuan central parity rate set Wednesday at 6.2881, the People's Bank of China appears to be guiding the yuan into depreciation to limit the increasing regional threat to its exports, which have already been affected by lacklustre economies abroad.

Late last month, China's foreign exchange regulator, Li Gang, told Bloomberg that the yuan was "pretty much close to the equilibrium level" and called on G20 nations to better communicate and co-ordinate policy on foreign exchange rates. The Japanese yen has weakened amid looser monetary policy and a new inflation target of 2 per cent.

"I think there is concern, there is fear about competitive devaluation given the Japanese yen situation," said Ren Xianfang, a Beijing-based China economist at IHS Global Insight. "There definitely is pressure … for the government to at least not let the yuan appreciate rapidly."

So what of plans to internationalize the yuan by allowing it to trade with greater flexibility? The currency's trading band still limits fluctuation according to central planners' comfort, though it has gradually widened over the past year. And moves to make the yuan more international are continuing; Taiwan's banks conducted their first trade in yuan on Wednesday under a new yuan-clearing arrangement with the mainland, allowing it to join the other offshore yuan-trading centres Hong Kong, Singapore and London.

"As long as the Japanese yen weakens sharply against the U.S. dollar, and thus depreciates significantly versus the yuan, the risk is that the People's Bank of China will try to stabilize the value of its currency against its basket by weakening it against the U.S. unit, or at least preventing appreciating from resuming," said Dariusz Kowalczyk, a Hong Kong-based senior economist for Crédit Agricole-CIB. "When the Japanese yen stops falling, the policy of firmer fixings will resume."

Still, others say it's too soon to tell how long this policy shift will last as China enters the Year of the Snake this weekend.

"It's a very marginal acceleration of depreciation, we don't know if this is a long-term political course or just a short-term fluctuation by market forces," Ms. Ren said.

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"It's still unclear right now," said Harrison Hu, a Beijing-based China economist for UBS Securities, of the apparent interventions.

But he believes the currency has simply stabilized and will see little change this year.

"If the yuan-yen does keep appreciating further, we think the Chinese authorities will probably bring in more flexibility to the [yuan] exchange rate, not necessarily pegged to the U.S. dollar.

"In the medium and long term, the authorities still pursue wider use of the renminbi [yuan] in the global market … a stable and relatively strong value of renminbi wil be preferred by authorities," he said.

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