Forex Management

11/14/2011

Currency Analysis

Peoples Republic of China

Effort by: Shashank Dhariyal

China Quick Facts

Growth

Real GDP grew a stronger than expected: 11.5 percent in the first three quarters of 2007. GDP growth is projected to be 11.5 percent in 2007. In 1985 average income in China was $293; in 2006 the average income is $2,025.

China and the Global Economy

China achieved 14 percent of the world economy on purchasing power parity basis in 2005 (second to the United States). China contributed one-third of global economic growth in 2004. In 2004, China accounted for half of global growth in metals demand, and one-third global growth in oil demand. China's economy has high energy intensity. The country uses 20-100% more energy than OECD countries for many industrial processes. Automobile standards lag behind European standards by ten years. And China has 20 of the world's 30 most polluted cities, largely due to high coal use and motorization. Foreign exchange reserves exceed $1000 billion (exceed Japan), and are growing at about $200 billion a year. About 20 percent of China's exports go to the United States.

China and the World Bank

In FY07, China borrowed $1.641 billion from the World Bank. Since becoming a member of the World Bank in 1980, the Bank has supported more than 284 projects in China, with a total of $42.2 billion in loans and credits of which70 projects are ongoing, making China's portfolio one of the largest in the Bank. China graduated from the International Development Association in 1999.

Currency History

CNY PROFILE Inflation: 6.5% Nicknames: kui, fn Coins: Freq Used: 1, 10 Rarely Used: 50, 1, 2, 5 Banknotes: Freq Used: 5, 10, 20, 50, 100, 1 Rarely Used: 2, 10, 20, 50

The Renminbi (RMB, sign: ; code: CNY; also CN, and CN) is the official currency of the People's Republic of China (PRC). Renminbi is legal tender in mainland China, but not in Hong Kong or Macau. It is issued by the People's Bank of China, the monetary authority of the PRC. Its name (simplified Chinese: ; traditional Chinese: ; pinyin: rnmnb) means "people's currency".

The primary unit of Renminbi is the yun (). One yuan is subdivided into 10 jio (), which in turn is subdivided into 10 fn (). Renminbi banknotes are available in denominations from 1 jiao to 100 yuan (0.1100) and coins have denominations from 1 fen to 1 yuan (0.011).

Thus, some denominations exist in coins and banknotes, but they are usually used in coins if under 1. Coins under 0.1 are used infrequently. Through most of its history, the value of the Renminbi was pegged to the U.S. dollar. As China pursued its gradual transition from central planning to a free market economy, and increased its participation in foreign trade, the Renminbi was devalued to increase the competitiveness of Chinese industry.

It has been claimed that the current official exchange rate is lower than the value of the Renminbi by purchasing power parity, undervalued by as much as 37.5%. Since 2005, the Renminbi exchange rate has been allowed to float in a narrow margin around a fixed base rate determined with reference to a basket of world currencies. The Chinese government has announced that it will gradually increase the flexibility of the exchange rate. China has initiated various pilot projects to "internationalize" the RMB in the hope that it will become a reserve currency over the long term.

Regulatory Body

The People's Bank of China (PBC) was established on December 1, 1948 based on the consolidation of the Huabei Bank, the Beihai Bank and the Xibei Farmer Bank. In September 1983, the State Council decided to have the PBC function as a central bank. The Law of the People's Republic of China on the People's Bank of China adopted on March 18, 1995 by the 3rd Plenum of the 8th National People's Congress has since legally confirmed the PBC's central bank status.

With the improvement of the socialist market economic system, the PBC, as a central bank, will play an even more important role in China's macroeconomic management. The amended Law of the Peoples Republic of China on the People's Bank of China, adopted by the 6th meeting of the

Standing Committee of the 10th National People's Congress on December 27, 2003, provides that the PBC performs the following major functions:

(1) Drafting and enforcing relevant laws, rules and regulations that are related to fulfilling its functions;

(2) Formulating and implementing monetary policy in accordance with law;

(3) Issuing the Renminbi and administering its circulation;

(4) Regulating financial markets, including the inter-bank lending market, the inter-bank bond market, foreign exchange market and gold market;

(5) Preventing and mitigating systemic financial risks to safeguard financial stability;

(6) Maintaining the Renminbi exchange rate at adaptive and equilibrium level; Holding and managing the state foreign exchange and gold reserves;

(7) Managing the State treasury as fiscal agent;

(8) Making payment and settlement rules in collaboration with relevant departments and ensuring normal operation of the payment and settlement systems;

(9) Providing guidance to anti-money laundering work in the financial sector and monitoring money-laundering related suspicious fund movement;

(10) Developing statistics system for the financial industry and responsible for the consolidation of financial statistics as well as the conduct of economic analysis and forecast

(11) Administering credit reporting industry in China and promoting the building up of credit information system;

(12) Participating in international financial activities at the capacity of the central bank;

(13) Engaging in financial business operations in line with relevant rules;

Renminbi and foreign exchange control

The Renminbi (RMB), China's legal currency, is issued and controlled solely by the People's Bank of China. RMB exchange rates are decided by the People's Bank of China and issued by the State Administration of Foreign Exchange, the latter exercising the functions and powers of exchange control.

In 1994, China reformed the foreign exchange system, combined the RMB exchange rates, adopted the bank exchange settlement system and set up a unified inter-bank foreign exchange market. On this basis, China included the foreign exchange business of the foreign-invested enterprises in the bank's exchange settlement system in 1996. On December 1, 1996, China formally accepted Article 8 of the Agreement on International Currencies and Funds, and realized RMB convertibility under the current account ahead of schedule. Meanwhile, China has been active in promoting bilateral currency exchange between ASEAN and China, Japan and the Republic of Korea.

At the end of 2004, China's foreign exchange reserves reached US$609.9 billion and its share in the International Monetary Fund has risen from 11th to 8th place. The variety of financial businesses has been increasing steadily, and China has opened an array of new businesses to become integrated into the various aspects of modern international financial business, such as consumer credit, securities investment funds and insurance-linked investments.

 VS $
China's yuan has hit a record high against the US dollar after the US Treasury department said the Chinese currency was undervalued but not manipulated. The People's Bank of China (PBOC) fixed the yuan's mid-point at 6.4856 against the US dollar on Monday. China has been accused by the US and other developed economies of keeping the value of its currency artificially low to boost its exports. China is the world's biggest exporter. The US and other major economies have said that China's policy of keeping the value of its currency low gives an unfair advantage to its manufacturers. There have also been concerns that China's currency policies have also been responsible in part for big trade imbalances with its trading partners.

They want to do it in a way that is sustainable and gradual that is a way that gives Chinese exporters enough time to adjust. The Chinese economy has to be in a position to absorb the appreciating currency Peter Esho

There have been repeated calls in the US to label China a currency manipulator, given Beijing's currency policies and reluctance to let the yuan trade freely. China however has maintained that while it is willing to allow the yuan to appreciate, its pace has to be gradual. It said that a sudden rise in the yuan will not only be detrimental to its export sector but will also have a negative impact on the overall economy. In its report released on Friday, the US Treasury Department said that although China's currency was undervalued, the country was not a currency manipulator. Analysts say that while there has been considerable pressure within the US, it seems that the Treasury Department had taken on board China's concerns about a sharp rise.

In an attempt to show its intent on letting the value of its currency rise, China loosened its peg to the US dollar in June 2010. The yuan has gained more than 5% against the dollar since then. However the US Treasury report said that the rise has not been up to their expectations. "Treasury's view is that the progress thus far is insufficient and that more progress is needed."

Many analysts are of the view that China is trying to make sure that the appreciation in its currency has the minimum impact on its economy. Since China is so reliant on its export sector "the government will not let exporters suffer, just to appease foreign concerns."

China's currency policy has not only created problems with its trading partners. It has also contributed to domestic problems. Inflation in China has been rising sharply as the costs of oil, food and other essential commodities continue to spike. Consumer prices rose by 5.3% in April compared with the same month a year ago. Analysts say that while China has to take care of the interests of its export sector, it has also got to keep in mind that a lower valued currency makes imports more expensive and adds to inflation.

The graph depicts the value of Chinese Yuan against American Dollar.

120 days

latest (Nov 11) 6.3422

lowest (Nov 9) 6.33192

highest (May 30) 6.48318

Hedging for Renminbi

China began the domestic trading of yuan options against other currencies beginning April 1 in an effort to meet market demands of more currency hedging tools as the yuan becomes more flexible. The State Administration of Foreign Exchange (SAFE) said that it will launch trading of so-called "European-style" yuan options on the interbank market. In a European-style option, investors can only exercise their rights after the contracts expire.

Also, banks and enterprises will be allowed to buy options at the initial phase, not to sell them, a move, the regulator said, that aims to ease foreign exchange trading risks. It also said the trading will be restricted to firms using it for real trading and investment, rather than speculation. Banks involved in the business should have more than three years of experience in trading foreign-exchange forwards. Options give the buyer the right, not the obligation, to buy or sell currency at a specified exchange rate during a stated period of time. "As China's yuan exchange rate is becoming more flexible, enterprises' and banks' demands for hedging tools are on the rise, which boosts the development of the foreign exchange derivative market", the SAFE said.

Except for during special conditions such as the global financial crisis, the yuan's flexibility had been increasing since the country shifted to a managed floating exchange rate regime in 2005, and "it will be the future trend".

Current conditions of domestic foreign exchange market are suitable for the launch of the business, and more marketoriented interest rate systems and banks have had some experiences in trading foreign currency options. The move is a "major breakthrough" for the currency in the financial derivative investment market. A more developed foreign exchange derivative market would help push forward the yuan's globalization, he said.

But most importantly, it will help Chinese enterprises and traders avoid the risks of exchange rate fluctuations and, at the same time, receive returns from such investments, he added. The SAFE announced, month, that it will launch a currency swap business for bank customers beginning March 1 in another move to help enterprises hedge against exchange rate risks.

Conclusion

As trade within Asia becomes increasingly centered on China, it will start to make sense to denominate that trade in yuan. And since the yuan is already a good store of value, it will soon also become a medium of exchange. Once these conditions are in place, it will make sense to use the yuan as a reserve currency.

The Yuan will be the worlds main reserve currency within ten years ------- Anonymous!!