China in no mood to let G7 budge it on yuan

BEIJING (Reuters) - Like a broken record, foreign finance ministers keep calling for the yuan to rise more quickly.

Like a broken record, economists keep arguing that without a stronger yuan, China's monetary policy will remain hamstrung.

And like a broken record, Chinese leaders keep promising they will indeed let the yuan, or renminbi, move more freely.

"We will improve the RMB exchange rate regime and gradually make the RMB convertible under capital accounts," President Hu Jintao intoned on Monday at the Communist Party Congress.

The problem for Group of Seven rich industrial nations, which are likely to take China to task once more when they meet in Washington on Friday, is that Beijing is being far too slow to match words with deeds.

The yuan CNY=CFXS has risen just 8 percent against the dollar since it was depegged from the U.S. currency in July 2005. It has fallen by about the same amount against the euro and has barely appreciated against a basket of currencies.

What might change the yuan's trajectory?

Not the G7 meeting, according to Mingchun Sun, an economist with Lehman Brothers in Hong Kong. "For China's leaders the Party Congress is much more important than the G7. They don't have time to spend on it," he said.

Making Sun's point, central bank governor Zhou Xiaochuan is staying at home and sending his deputy, Wu Xiaoling, to listen to the growing chorus of complaints about China's currency policy.

THE POLITICS STAY THE SAME

China has consistently stressed that greater yuan flexibility is just one element of its strategy for reducing the record trade surplus that is making its economy imbalanced and riling the G7.

Cutting tax rebates for exporters, imposing taxes to deter exports of low-end goods and raising artificially low production costs -- by liberalising resource prices and increasing the cost of treating pollution -- are also important pieces of the puzzle.

The emphasis that Hu put on balanced growth and "scientific development", particularly to reduce environmental degradation, suggests Beijing will persevere with this broad policy thrust.

"So unless they think they're not going to make sufficient progress in those other areas, I think they will still keep exchange rate appreciation at around 5-6 percent next year," Sun said.

Stephen Green and Gavin Redknap of Standard Chartered Bank, who also have low expectations of the G7 meeting, have pencilled in a 5.5 percent rise in the yuan next year from a target of 7.4 per dollar at the end of December.

The yuan stood around 7.51 on Friday, but, if anything, that year-end goal could be too aggressive, Green and Redknap said.

They said some U.S. officials they have spoken to seem to have lost hope that China is serious about currency reform.

"We are not looking for a significant pick-up in the pace in the immediate aftermath of the 17th Party Congress. The politics do not change -- and depending on who replaces People's Bank governor Zhou Xiaochuan, the chances of mild appreciation acceleration may even fall," they wrote in a note to clients.

One of the favourites to replace Zhou, who has been in his job for nearly five years, is the conservative securities regulator Shang Fulin.

The politics do not change because, as Hu's speech made crystal clear, China needs fast growth not only to raise living standards in what is still a poor country but also to justify the party's political monopoly.

Seen in that light, sanctioning a surge in the currency that could destroy export jobs and expose tens of millions of farmers to competition from cheaper imports would be a risky option.

Chinese firms had coped well so far with the stronger yuan, Export-Import Bank President Li Ruogu said on Thursday. "But their capacity is not unlimited. If the yuan rises too fast, it will lead to more pressure and challenges for them," he said.

STOCKS CONCERN

China could change its tune if enough policy makers come round to the view that the central bank risks losing control of monetary policy because of the undervalued, semi-fixed yuan.

Money and credit growth unexpectedly spurted in September. On the other hand, inflation looks to have peaked and the People's Bank has not had noticeable difficulty sterilising the massive liquidity inflows generated by the trade surplus.

Another possible trigger for change, says Adrian Foster with Dresdner Kleinwort in Beijing, is the sky-high domestic stock market, which some view as a bubble waiting to burst.

Seeing the yuan as a one-way bet, investors have boosted the main Shanghai share index .SSEC 400 percent since early 2006.

To counter investors' "home bias", Foster says the market needs to believe that the yuan's trend appreciation is over.

"China has realised that they're creating their own problems in the equity market through the slow, steady appreciation."

Foster says China has already let the yuan rise faster this year and believes the recent stalling in its climb is just a pause.

He expects the yuan to reach 7 per dollar by mid-2008 -- a level that would disarm criticism of Beijing in the run-up to November's U.S. presidential election and would give Chinese reformers the cumulative appreciation of about 20 percent that some were looking for when China untethered the yuan in 2005.