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Chinese yuan to move freely

Friday 25th June 2010
After months of speculation, the Chinese government has announced its plan to allow its currency to move freely. Charlie Awdry, Manager of the Gartmore China Opportunities Fund, considers the repercussions of such a move for the markets and his Fund.

What has happened?
Chinese authorities have announced plans to make the Chinese yuan exchange rate more flexible. The Central Bank will aim to keep the currency stable and has stated that there will be no immediate revaluation of the currency. The yuan has been pegged to the US dollar since July 2008, as China sought to insulate its export sector from the financial crisis. That policy has come under attack in the west, especially in the US.

Why has this happened?
The Chinese have found themselves in a tough situation over the yuan in recent months. By ensuring the currency remained low, China was providing its exporters with an advantage at the expense of foreign competitors. More recently, US dollar strength has meant that the yuan has strengthened against other emerging market currencies. It is this volatility against other trading partners which has perhaps become more difficult. As a result, China has come under increasing international pressure to change its currency policy. The move which comes ahead of the G20 summit later this month has reduced fears of a possible trade war between China and the US.

How is the news being received?
Global stock markets and Asian currencies initially rose strongly following the announcement but have since fallen back. Foreign currency forwards had moved sharply higher as traders expected the currency to appreciate over the coming year. General market consensus suggests that the Central Bank will allow the yuan to appreciate some 2-3% over the next 12 months.

Our view

Despite the move making Chinese exports less competitive, the announcement will undoubtedly be welcomed by the rest of the world and will improve China’s diplomatic relations with the west and in particular with the US. We expect China will benefit as the move allows for more flexibility in policy going forward and should in turn drive consumption higher. Those businesses with assets denominated in the yuan should also benefit as the currency appreciates. The change in policy will make it easier for Asian countries that compete with China for exports to allow their own currencies to rise. Nevertheless, with European economic weakness hindering export growth, we don’t expect to see any large currency moves in the short term.

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Mike Jones

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