China flags more fexible yuan
(Reuters)
Updated: 2005-11-25 17:00

A trader in Hong Kong saw the deal differently. He said the bank was trying to cool, not fan, expectations of yuan strength.

"It means that they are sending a signal to the market that in one year the maximum move allowed in the yuan will be to 7.85, so maybe they are trying to calm down the market a bit," he said.

In the non-deliverable forwards market, yuan for delivery in a year's time duly eased to 7.7750 per dollar from 7.76 before the swap was launched.

In any event, a further appreciation would be welcome to the United States, which has been pressing Beijing to make good on its promise to eventually let market forces drive the yuan.

Because China is on course for a current account surplus of more than 8 percent of gross domestic product this year, economists say those forces of supply and demand point firmly to a stronger yuan, at least in the short term.

The tide of cash generated by China's swelling surplus is in fact another reason for launching the currency swaps market: it gives the central bank, wary of an inflationary surge in money supply, another money market instrument with which to soak up the yuan it issues when it buys dollars coming into the country.

Market sources confirmed a report in the official Shanghai Securities News that the central bank would enter into currency swaps once or twice a week.

Yet another benefit of the deal would be to help build an onshore market in forwards and swaps driven by domestic banks rather than foreign players that are more speculatively minded.

"The swaps are designed to help businesses and individuals to hedge against exchange rate risk. This will help set a benchmark for currency swaps," said Xiao Minjie, an economist with Daiwa Institute of Research in Shanghai.

China is trying to offer firms and institutions tools to hedge against new-found currency risk since revaluing the yuan by 2.1 percent on July 21 and letting the currency float, albeit within bands that for now are tightly managed.

China granted approval for currency swaps -- which allow counterparties to hedge exchange rate risk by swapping cash flows -- for the first time in August, when it also launched the country's first yuan onshore forwards on the interbank market.