International | Aug 23 2006
By Chris Shaw
For those waiting on the Chinese to move to a fully flexible exchange rate Danske Bank has some advice – don’t hold your breathe as it is not going to happen in the short-term.
In the bank’s view the hurdle remains the choice China has made between the three economic objectives of capital mobility, monetary independence and a floating exchange rate, as these it refers to as the "impossible trinity" in that only two of the three are achievable at any one time.
China has chosen currency stability and independent monetary policy, meaning it has retained some control over the mobility of capital. Danske Bank points out though this is not an effective policy in what is now a global financial structure, particularly as it can result in an inefficient allocation of capital.
Evidence of this is being seen daily in China as some industries continue to grow strongly despite government attempts to slow them, while at the same time the gap between the growth prospects of urban and rural citizens continues to widen.
Despite this policy approach, Danske Bank expects the Chinese to gradually incorporate greater flexibility into its exchange rate policy, which while purportedly set against a basket of currencies has in reality been nothing more than a peg against the US dollar. The likely driver of this increased flexibility is the increased attention its exchange rate is likely to receive in coming months thanks to a number of political events such as the G7 finance ministers meeting and the IMF annual meeting, both scheduled for next month.
The attention these bring and the pressures being exerted on the Chinese to revalue their currency are likely in the bank’s view to result in a gradual appreciation against the US dollar, with the first step likely to be a widening of the trading band.
This greater flexibility leads the bank to forecast a renminbi rate against the dollar of 7.90 in three months, 7.80 in six months and 7.65 in 12 months, against a level of just under 8.00 now. So yes, things are likely to change in terms of the Chinese currency according to Danske Bank, just a lot slower than most in the market (and particularly in the US) would like.
