China's currency, the yuan, was set to trade at 6.992 yuan against the US dollar on Thursday, breaching the 7-yuan mark for the first time since the government unpegged it from the dollar in 2005.

Following an overnight fall of the dollar, the central parity rate of the yuan, or Renminbi (RMB), gained 105 basis points to 6.992 yuan against the dollar on Thursday, according to the China Foreign Exchange Trading System.

Shen Minggao, an economist at Citigroup in Beijing, said that like many economists, he was not surprised to see the yuan break the 7-yuan mark.

"It was quite natural," he said, citing the dollar's fall against other major currencies, especially the euro, since the second half of last year along with an unfolding US credit crisis plaguing the US economy.

China ended the currency's peg to the dollar in July 2005, and since then the yuan's reference rate has been set against a currency basket that also includes the euro, yen, won and British pound.

The yuan has gained 4.47 percent this year based on Thursday's trading price, or 18.27 percent from 8.2765 yuan against the dollar before the new currency regime was imposed.

Zhuang Jian, a senior economist with the Asian Development Bank mission in China, also believed a weaker US dollar was the most direct factor behind the accelerated appreciation of the yuan.

The value of Chinese currency stayed above eight to the dollar for many years before the 2005 regime reform. The yuan broke the 8-yuan threshold on May 15, 2006.

Zhuang said the breakthrough was an indication of the country's efforts to shift from a heavy reliance on exports and investment as well as to go after a more balanced trade structure.

Accelerated pace to ease

The quickened pace had prompted many overseas banks to raise their forecast of the yuan's 2008 annual gain against the dollar. Last month the Standard Chartered Bank revised its prediction from 9 percent to 15 percent.

However, economists agreed that the fast pace registered in the first quarter would probably not continue throughout the year.

"We do expect continued appreciation going forward, but not quite at the breakneck pace of the first quarter," the Switzerland-based UBS Investment Bank said in a report released on Wednesday.

The bank said the "stabilization of the US dollar in 2008" and "greater signs of stress in the export sector" due to the US and global slowing would help moderate the pace.

Some economists even expected that the yuan may not unilaterally rise against the dollar for the rest of the year.

Shen Minggao said the appreciation pressure on the yuan would ease and the yuan may even depreciate against the dollar, once the dollar became stronger.

Tan Yaling, a research analyst with the Bank of China, also expected the dollar to rebound in the second half, and said the 2008 US presidential election could be a plus to making the dollar stronger.

She continued to anticipate that the yuan would continue to appreciate in the first half, but would report falls against the dollar from time to time in the second half as the dollar rebounded.

Zhuang also expected the yuan to appreciate more slowly for the rest of 2008 and said the year-end rate would probably be about 6.8 yuan per dollar.

The UBS report also pointed out that China's currency had not gained much against other major currencies, as nearly every major currency had rallied substantially against the dollar in the first quarter.

The yuan had actually depreciated against the euro and the yen, said Li Yang, director of the Institute of Finance and Banking under the Chinese Academy of Social Sciences.

The impact on China's economy

"A swifter appreciation of the yuan may not be a good choice for China at the moment," said Tan Yaling. A rising yuan would raise costs for the whole economy and make manufacturers' situation more difficult, especially when Chinese companies began to go overseas, she added.

However, Zhuang Jian said the country should continue to let the yuan appreciate against the dollar despite the risks of an economic slowdown and possible job losses at export-oriented enterprises.

He added that a revaluation of the yuan would give the country a good opportunity to restructure the economy and address its trade balance.

China's major trading partners have repeatedly argued that the yuan was undervalued, which they say makes Chinese products artificially cheap and causes a trade imbalance in China's favor.

The growth of China's trade surplus began to slow in the fourth quarter in response to several Chinese moves to rein in exports.

Weakening US demand helped pare China's trade surplus to 8.56 billion US dollars in February, roughly one third of the year-earlier level. The sharp decline could counter complaints from the United States and European Union over China's trade surplus, which hit a record 262.2 billion US dollars in 2007, up 47 percent year-on-year.

Yet, the role of currency revaluation in containing China's trade surplus remains uncertain. Tan said she believed the yuan's appreciation hadn't helped rein in the trade gap or curb the growth of foreign reserves.

Chinese manufacturers have already felt the pinch of the rising yuan. An industry survey released this month said that rising costs and the stronger currency were squeezing Chinese cotton textile companies, with nearly half considering going out of business.

Tan also said that the central bank should introduce more flexibility into the currency by further widening the yuan's daily trading band, which is now 0.5 percent. Doing so could make speculation in the currency more difficult, she said.

A helping hand in curbing inflation

Inflation took its biggest jump in nearly 12 years in February, when the consumer price index (CPI) rose 8.7 percent year-on-year. Little easing in inflation is expected for March or the first quarter. Some economists, such as Zhuang, have said that a faster yuan appreciation would help relieve inflationary pressure.

Others disagreed. Zuo Xiaolei, chief economist at Galaxy Securities, said that currency appreciation couldn't temper China's inflation. That view was echoed by Tan Yaling, who pointed out that the yuan was actually strengthening in tandem with escalating inflation.

"There's no evidence that currency strengthening would have any near-term effect" on the inflation rate, according to the UBS report.

Zhuang said, however, that a stronger yuan would curb inflation over the longer term.

Central bank governor Zhou Xiaochuan said last month that the country would rely on comprehensive measures, not just the currency's value, to fight inflation, though he admitted that an appropriate appreciation of the yuan could help check inflation.

(Xinhua News Agency April 10, 2008)