Non-Convertible Chinese Yuan – Part II

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Tuesday December 18, 2007 : Forex Metrics Currency Index 1.2632 Change In Index -0.0029

Part II
How Strong is Yuan?

Phase II :

This phase would be after 12-15 months from the beginning of first phase. It should make the current and capital account convertible for everyone without limit. However, global trading of the Yuan would be prohibited, only operated by the Central Bank of China.

Under this Phase, due to increase in the value of yuan and consolidation of the economy, the Chinese economy may face a soft patch ; stock prices would be consolidated, purchasing power parity would be closer to that of the developed countries, level of poverty would fall, standard of living would improve and mainly, the structure of employment would shift. In reality, the outlook of the economy as a whole, would experience transformation.

This phase would be a very bumpy ride for the Chinese economy and may last 12-18 months from the end of first phase, but will be dependant on the economy’s response to the major change.

During this phase, the Yuan would appreciate to 4.7000 – 5.2000 against USD.
Under these circumstances, if the Chinese government is willing to stay firm and give a final push for fully convertibility, then ;

Phase III : The final phase – Yuan fully convertible.

Yuan will be traded freely, globally. At this stage yuan’s value will be determined by the market based on economic cycle, interest rate, etc.

Conclusion: Although the Chinese government desires and has the capacity to make the yuan fully convertible, the Government is not mentally prepared for the change which would lead to a market driven economy.

* Chinese banking sector is not up to the mark ;
* Chinese growth can sustain competition only through pegged currency with USD or basket of currency, Any free market exposure may lead to a fall in growth rate and may lose the competitive edge against Japan and Korea.

In order to avoid this situation of losing the edge against competitors like Japan, Korea and all south east Asian countries, the common currency, Asian Currency Unit (ACU), has been prompted by all these nations to be on the same page on the fundamental based Euro.

We do not see Yuan fully convertible even from a long term perspective. However, the Yuan would definitely be more flexible and the only hope of fully convertibility is only through the Asian Currency Unit (ACU).

(Please refer to Part I of this article.)

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