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China to wield leverage of exchange rates
Updated: 2005-07-25 14:01

China's final revocation of the yuan's pegging to the dollar on Thursday has broken a decade-long rigid exchange rate system and allowed the currency to regain its leverage on the economy.

As of 7 pm Thursday, the yuan, which had been fixed near 8.27 per dollars since 1996 was tied to a basket of currencies of China's main trading partners.

The reform has raised the value of the yuan by 2.1 percent to 8.11 per US dollar Thursday. In the future, the yuan will be allowed to move in a range of 0.3 percent up or down from the previous day's close, according to China's central bank.

"This 'managed floating' policy will defend government's control of the China market and at the same time expand the floating range of the currency," said Ba Shusong, deputy director-general of the Finance Institute of the Development Research Center of the State Council.

"Moreover, Yuan's peg to a basket of currencies will prevent China's exports from being seriously impacted in the short term," he added.

Calling the country's exchange rates system "a rusty leverage shelved for a long time", Ba said it would take some time for China to make better use of the tool.

"An immediate drastic adjustment in the value of yuan would be improper at this time," he added.

Ha Jiming, chief economist of the China International Capital Corp, said that the chances of the yuan's continual appreciation were "poor" as this first step has already been made amidst the consensus and mutual understanding between China and the United States.

"A precondition for China to push forward reform on its exchange rates system is the steady growth of the economy," Ha acknowledged.

Under the previous rigid exchange rate system, Ba Shusong claimed, China's central bank had to control the money supply and capital flow on the condition of having a fixed exchange rate. The central bank's independence in establishing monetary policies was thus jeopardized.

"The new system will allow the central bank to act more actively and be less impacted by non-marketing forces," he said.

Since the current appreciation of yuan is quite modest, both of the two agreed that China's prudent monetary policies established earlier this year would remain unchanged.

"We won't expect the reform to leave much impact on China's macro economy," said Li Yang, a senior economist with the Chinese Academy of Social Sciences in Beijing, calling the concern of deflation "unnecessary".

"If companies and manufactures made no active response toward the appreciated yuan, deflation might occur. Judging from the past experience, however, our companies are smart enough to adjust their marking strategies and to sharpen their competitive edges," said Ba Shusong.

Although some small companies with mediocre profits may go broke, large companies will have a chance to purchase overseas recourses at lower costs and thus improve their productivity.

Fan Jianping, director of the Economic Prediction Department of the State Information Center, said the appreciation of yuan would also impel domestic companies to seek more technical innovation rather than simply rely on low prices when it comes to the competition in foreign trade.

Experts also agreed that energy-consuming industries such as iron and steel, non-ferrous metals and plastic rather than labor-intensive sectors would be most impacted.

The appreciation would help China to optimize its trade mix and restrict the exports of products in energy-consuming industries, they said.

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