China seen able to tell U.S. that yuan is near fair value

BEIJING Tue May 13, 2014 2:29pm IST

A U.S. $100 banknote is placed next to 100 yuan banknotes in this picture illustration taken in Beijing October 16, 2010. REUTERS/Petar Kujundzic

A U.S. $100 banknote is placed next to 100 yuan banknotes in this picture illustration taken in Beijing October 16, 2010.

Credit: Reuters/Petar Kujundzic

BEIJING (Reuters) - U.S. Treasury Secretary Jack Lew is pressing his counterparts in Beijing this week to ease their grip on the yuan after a sharp drop this year, but the Chinese now look to be in a strong position to argue the currency is reflecting market forces.

China says the yuan is near equilibrium after a rise of nearly one-third since its 2005 revaluation and as it adapts to what President Xi Jinping says is the "new normal" of more moderate growth -- and has support even from former critics.

"We can say with some confidence that the renminbi is now fairly valued, which is a striking change from even 2005, when the currency was undervalued by nearly 30 percent," Martin Kessler and Arvind Subramanian of the Peterson Institute for International Economics said in a report released this month.

Their calculation was based on a World Bank report that, based on purchasing power parity (PPP), China would this year overtake the United States to become the world's biggest economy.

"This change possibly heralds the end of nearly two decades of China's mercantilist development strategy based on boosting exports by keeping the currency artificially low," Kessler and Subramanian wrote.

The Peterson Institute, a Washington think tank and one of the most vocal critics of Beijing's currency policy, has previously accused the central bank of heavily suppressing the yuan's value.

In Beijing on Tuesday, Lew said China needed to move to a market-based exchange rate, following a warning from the Obama administration last month that the yuan was too weak.

The yuan was trading around 6.24 per dollar on Tuesday. It has fallen some 3 percent so far this year, in a move traders said was engineered by the People's Bank of China (PBOC) to shake the market out of the view that it was a one-way bet.

The currency had risen to a record high of 6.0434 in mid-January before weakening suddenly. It has lost ground in each of the first four months this year, hitting 18-month lows in April, but has but has gained slightly so far in May.

"Two factors still support slight yuan rises. One is that China still has a relatively big trade surplus, second is China wants to push forward yuan internationalization, "said Zhou Hao, China economist at ANZ in Shanghai.

But that view is not universal. Some analysts are worried about risks such as credit bubbles and a downturn in the property sector weakening the economy.

"There is a potential credit problem in China, so the currency should reflect some risk premium," said Kevin Lai, senior economist at Daiwa Capital Markets in Hong Kong, who expects it to fall another 8 percent by the end of 2015.

China's trade surplus, which has been used to support arguments that the yuan was massively undervalued, dropped to around 2 percent of gross domestic product in 2013. Capital controls also make it hard to gauge market equilibrium.

Zhang Yongjun, senior economist at China Centre for International Economic Exchanges (CCIEE), a well-connected think-tank in Beijing, said his own calculation based on PPP, also showed the yuan is no longer undervalued.

"The yuan is definitely not significantly undervalued and we

can even say the yuan is slightly overvalued," he said, estimating its fair value to be around 6.2-6.5 per dollar.

"They (U.S. officials) may be worried about recent yuan depreciation, but why cannot we allow the yuan to deprecate a bit given that there have been ups and downs in the U.S. dollar?"

(Editing by John Mair)

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