More Flexible Yuan

Following a roughly 2-percent fall in the exchange rate against the U.S. dollar in the first seven months of this year, the yuan began to rebound at the end of July. On November 12, the central parity rate of the yuan against the U.S. dollar hit 6.292, a record high in the past six months.

Due to a rising euro and a weakening dollar, along with a third round of quantitative easing launched by the U.S. Federal Reserve, expectations of the yuans appreciation have risen. Others argue the appreciation is triggered by the backflow of hot money since the Chinese economy has bottomed out and recent macroeconomic data have turned out to be more inspiring than expected. Under such circumstances, the private sector is more willing to exchange foreign currency for the yuan, and in an attempt to avert risks, institutions are striving to cut their dollar holdings in the inter-bank market.

However, statistics suggested hot money didnt flood into the Chinese market. In the third quarter, capital and financial accounts showed an outflow of $70 billion. The yuans appreciation, to a large extent, has something to do with the trade surplus and an increase in funds outstanding for foreign exchange. According to the General Administration of Customs, Chinas trade surplus reached $32 billion in October, a 45-month high. Strong expectations of yuan appreciation and a willingness to exchange foreign currencies for the yuan indicate the yuan may continue appreciating, but its scope is limited.

In April, the Peoples Bank of China expanded the daily floating range of the yuandollar exchange rates from 0.5 percent to 1 percent, making two-way fluctuations more obvious. After six months, the expansion has proven to be conducive to the stabilization of the yuan exchange rate and the formation of an effective pricing mechanism.

In the future, the focus must remain on further promoting the reform to improve the exchange rates flexibility regarding supply and demand.

But now the market is concerned with whether the yuan will continue to appreciate, the reasons if the yuan depreciates and what measures the central bank will carry out to make the two-way fluctuation of the yuan better reflect supply and demand.

In the short term, the exchange rates fluctuations are the result of different market expectations. If global markets believe Chinas economy has bottomed out and economic growth will be back on track soon, hot money will pour into the Chinese market, which is now the case. Two-way fluctuation can help the yuan edge toward an equilibrium rate of exchange.

Nevertheless, in the long run, exchange rates are decided by economic strength and competitiveness. In the first half of this year, a slowdown of the Chinese economy spurred hordes of economic organizations and hedge funds to pitch into short sales of the yuan, which resulted in its slight depreciation. The yuan eventually began to appreciate as the Chinese economy bottomed out in the third quarter.

As long as the economic policy stays on the right path and the government takes the froth out of the real estate market, the potential for Chinas economy is still huge.

In short, two-way fluctuation doesnt mean the yuan will cease to appreciate, but will approach an equilibrium rate of exchange. The yuans appreciation will still be a long-term trend.