Yuan's trading reform gains momentum

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China's move to widen the yuan's trading band has unveiled its attempts to speed up market-based currency exchange rate reform, which means more trading risks for its exporters and banks as well, analysts said.

The People's Bank of China, the country's central bank, said Saturday the daily limit of the yuan's trading against the U.S. dollar in the foreign exchange spot market will be lifted from 0.5 percent to 1 percent effective April 16.

The move, following a rise to 0.5 percent from 0.3 percent in 2007, is widely seen as part of the country's intent to gradually ease its grip on capital control.

To keep the exchange rate stable, China has set a more restrictive rule on the yuan's trading against the U.S. dollar compared with other currencies.

Reform speeds up

The expansion is expected to accelerate the market-oriented reform of the yuan's exchange rate, which will in turn push forward the country's economic reforms as a whole, analysts said..

"A more flexible yuan will help better identify market supply and demand and promote [the yuan's] price to reach a balanced level, which will facilitate the exchange rate's reform," said Ding Zhijie, dean of the School of Banking and Finance with the University of International Business and Economics.

As a crucial step of the exchange rate reform, the expansion shows the government is relaxing its control and moves to let the market play a bigger role, Ding said.

Zhuang Jian, a senior economist with Asian Development Bank, said a wider trading band will lay a foundation for the country's efforts to open the capital account and realize a free convertible exchange rate system.

A central bank study released in February said the time was ripe for China to open its capital account.

"By letting exchange rate act as a price leverage in allocating market resources, reforms in other sectors will also be liberalized," said Zhang Bin, a researcher at the Institute of Finance and Trade Economics under the Chinese Academy of Social Science.

Trading risks rise

Although the move was well-timed, analysts warned of foreign exchange trading risks for the country's exporters and banks.

Expanding the yuan's floating band is a significant step of the yuan's trading reform, but will also increase trading risks for export-oriented firms and banks in the short run, said Lian Ping, chief economist with Bank of Communications.

The move came as China's narrowing trade surplus has significantly eased the yuan's appreciation expectation and the yuan started being more actively traded against the U.S. dollar in both ways, Lian said.

The country posted a trade surplus in March from February's deficit of 31.48 billion U.S. dollars, the largest trade deficit in a decade.

Meanwhile, the yuan dropped to the year's low of 6.3359 against the U.S. dollar on March 15, and soon strengthened to 6.2858 on March 26, the highest since China started exchange rate reform in 2005.

Speculative capital inflows are also expected to ease, as the value of the yuan, which has gained over 30 percent against the U.S. dollar since 2005, is widely believed to have approached an "equilibrium" level.

"Under the circumstances, a widened trading band will not have too strong impacts on the market," Lian said.

But in the short term, banks and exporters should make preparations against risks stemming from exchange rate fluctuations, he noted.

Lian said exporters should buy financial derivatives to hedge foreign exchange trading risks, while banks should strengthen risk management on foreign exchange assets.

Lu Zhengwei, chief economist of the Industrial Bank, identified risks particularly for the country's more export-led manufacturing enterprises, suggesting risk-avoiding plans by these firms.

"Enterprises have to spend certain costs in making arrangements to guard against risks. Only after they get adapted, could [the yuan's] price reflect true market conditions," Lu said.

While anticipating that the yuan's exchange rate may drop against the U.S. dollar on Monday's trading, Liu Ligang, director of the economic research department of ANZ Greater China, said the move will encourage more enterprises to use the yuan as a settlement currency to reduce risks in the long run.

"All these mean that the country's financial market and products will brace for substantial development in the future," Liu said.