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China gives forex speculators a piece of its mind

China gives forex speculators a piece of its mind < News < Bet On Markets

The world of currency markets is one of winks, nods and secret handshakes. Key policy makers rarely, if ever, say exactly what’s on their minds. Chinese Premier Wen Jiabao has done just that and traders should pay close attention.

Wen said, as he often does, that China would not relax the currency’s fixed exchange rate to the dollar under pressure from other countries.

Yet he went a step further this week, issuing a warning of sorts to currency speculators.

«To be frank, it’s not possible to launch changes to the yuan when speculation is so rife,» he said. «Rampant speculative activities on the yuan,» he added, would make the introduction of any measures «impossible».

In other words, traders who test China’s resolve may only delay a change in its currency peg. It means that the more investment banks churn out reports predicting yuan revaluations — and the more speculators react to them — the longer the process may play out.

China understands how much the world wants it to let the yuan rise. Its officials also know it would be a powerful goodwill gesture that would reap political benefits in capitals all over the globe.

Yet China’s economy isn’t ready for a currency shift, and debt has much to do with it. The four biggest commercial banks in Asia’s second-largest economy are shackled with untold numbers of bad loans, putting its financial system in a highly fragile state.

Standard & Poor’s thinks it would cost $656 billion (R3.801 billion) to resolve bad loans at China’s banks, though some analysts say the figure is probably much higher.

In January, China began using tens of billions of dollars of foreign exchange reserves to bail out lenders, and it’s been pressuring bank executives to dispose of bad loans.

More recently, it set new rules designed to make it easier for overseas investors to buy the more than $450 billion of bad loans held by China’s four biggest commercial banks and their asset management companies.

Yet it’s a work in progress. The last thing China wants is currency instability for the first time since 1995, when it pegged the yuan.

China, Wen said, needed «a stable macroeconomic environment, a normal market mechanism and a healthy financial system» before it altered the peg. «China needs to consider impact of the yuan on China and on the region.»

That’s little comfort to Asian governments struggling to adjust to the dollar’s 5.2 percent drop against the euro and 4.1 percent slide against the yen this year. As the dollar falls, China grows even more competitive in Asia.

The trend threatens the export industries of the 10 members of the Association of Southeast Asian Nations, or Asean.

The good news is that this week’s Asean meeting in Vientiane may be a harbinger of Asian governments looking past China’s dollar peg and letting currencies rise.

«We have to live with the fact that there will be a weaker US dollar next year,» said Indonesian trade minister Mari Pangestu. «I don’t think Indonesia should depreciate its currency to maintain its export competitiveness.»

Since Indonesia is by far southeast Asia’s biggest economy, such thinking shouldn’t be dismissed.

Japan also has shocked currency traders in recent weeks by doing nothing as the yen surged against the dollar.

South Korea, which, like Japan, tends to manage its currency closely, also has been more tolerant of the rising won.

It’s an important step for this region — a sign of confidence that may attract more foreign capital and lower bond yields.

It will encourage economies and companies to reform instead of relying on cheap exchange rates as a crutch. And letting the dollar fall may be necessary to get record US budget and current account deficits under control.

Japan’s is by far Asia’s biggest economy; only when Tokyo lets markets set the yen’s value will China and others follow suit.

By William Pesek

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