Currency may rise as stocks advance and bonds decline

SINGAPORE - China's yuan may hit a 17-year high in the coming week as stocks rise and bonds fall after the People's Bank of China (PBOC) raised interest rates for the third time in four months to curb inflation, if history is a guide.

The currency of the world's fastest-growing economy traded at 6.5824 per dollar as of 9:43 am in Shanghai, a 0.2 percent gain from its close on Feb 1, the last day of trading before the week-long Lunar New Year holiday.

It reached 6.5808 on Jan 21, the strongest level since China unified official and market exchange rates at the end of 1993. The one-year interest-rate swap jumped 19 basis points to 3.84 percent.

Emerging economies are weighing the need to curb inflation against the risk of attracting speculative capital from near-zero interest rates in the United States and Europe. China's base rate is still below the nation's inflation rate, giving savers an incentive to spend their money rather than keep it in the bank.

"They fear the risk of overheating," said Thomas Rutz, head of emerging markets and currency at Clariden Leu AG in Zurich, which manages $1.3 billion in developing-market assets. "Tightening in the currency should go in line with the policy rate tightening. I still believe in the yuan going to 6 per dollar this year."

The central bank's quarter-percentage point increase in the one-year deposit rate to 3 percent still leaves China's benchmark below Brazil's 11.25 percent, India's 6.5 percent and Russia's 7.75 percent, according to data compiled by Bloomberg. China's inflation may have climbed to as much as 6 percent in January after snowstorms damaged crops and as demand climbed before the holiday, according to Daiwa Capital Markets.

China's currency has appreciated 3.7 percent since June, helping to reduce import costs. It climbed 0.6 percent in the week after the last interest-rate rise on Dec 25 and 0.3 percent following the prior increase on Oct 19.

"The yuan will end up being stronger than what the market is discounting in a year's time," said Venkatraman Anantha-Nageswaran, the global chief investment officer in Singapore at Bank Julius Baer & Co, which oversees some $172 billion of assets. "The final outcome in one year's time will be between 6.2 and 6.4."

China's currency will appreciate 4.5 percent in the remainder of this year, according to the median forecast of 25 analysts surveyed by Bloomberg. India's rupee is expected to gain 3.3 percent, while Brazil's real and Russia's rouble are forecast to fall 1.8 percent and 3.8 percent respectively, separate surveys show.

China's government bonds fell this year, driving 10-year yields to their highest level since September 2008, as banks reined in demand for the securities after being ordered to set aside more funds as reserves. The rate rose 12 basis points to close at 4.03 percent on Feb 1, according to data compiled by Bloomberg. It increased eight basis points, or 0.08 percentage points, after China last raised rates.

"As they raise interest rates more, it's an admission that controlling money supply in China is not working to curb inflation," said Kobsidthi Silpachai, head of capital markets research at Kasikornbank Pcl in Bangkok. "It also shows that they need to eventually make the yuan more flexible."

Five-year credit-default swaps on China's bonds rose 1 basis point on Tuesday to 74, according to CMA prices in New York. Credit-default swap indexes are benchmarks for protecting debt against default and traders use them to speculate on credit quality. An increase suggests deteriorating perceptions of creditworthiness and a drop shows improvement.

China's stocks recovered from initial losses on Wednesday, lifting the CSI 300 Index 0.05 percent higher to 3,078.75. In the week following October's interest-rate increase, the CSI 300 climbed 2.7 percent. The gauge retreated 1.1 percent in the week after the Dec 25 revision.

The CSI 300 is still 14 percent below where it was at the beginning of last year, before China began tightening monetary policy. In addition to raising rates, the PBOC has raised the reserve-ratio requirement for major banks seven times since the beginning of 2010 and introduced stricter policies on lending for second- and third-home purchases. "This was pretty much in the price," said Anantha- Nageswaran at Julius Baer. "China shares are not expensive at this stage."

China's policymakers also raised the one-year lending rate to 6.06 percent from 5.81 percent, effective from Wednesday. The central bank moved on the last day of a weeklong holiday and before a report next week that may show consumer prices rose 5.3 percent in January, according to the median estimate in a Bloomberg News survey of economists. That would be the highest inflation rate since July 2008.

Consumer prices rose 4.6 percent in December and 5.1 percent in November, the most in 28 months, while the economy expanded 9.8 percent in the fourth quarter.

Bloomberg News

(China Daily 02/10/2011 page14)