CURRENCY markets are bracing for volatile trading ahead of China's move on Wednesday to allow the yuan to be traded against eight extra currencies, including the Australian dollar. The reform is being viewed as a precursor to the much-awaited upward revaluation of the yuan, which would hamper China's export competitiveness to the benefit of the US.
While China's central bank on Friday dismissed reports of an imminent change to its policy of pegging the yuan-$US rate, the Government has also said it intends to surprise the market with such an announcement. Wednesday's forex market reform is seen as a step towards China's currency liberalisation by boosting the yuan's liquidity.
"There will be nervous traders watching their screen on May 18 (Wednesday)," AMP Capital Investors chief economist Shane Oliver said. "The market was pricing (a revaluation) in, but that reversed in the last couple of days. If sentiment reverses again, you might see big swings."
A revaluation would most likely involve a widening of the narrow 0.3 per cent band in which the yuan is allowed to vary against the $US. US-led pressure for a revaluation has been mounting, given the nation's current account deficit, which has been fed by cheap Chinese imports.
A stronger yuan, in contrast, would boost China's internal consumption by making exports cheaper.
Australian exports would also become cheaper for Chinese buyers, while Chinese imports to Australia would become become more expensive, creating inflation and interest rate pressures, but improving out current account deficit.
"We expect China's authorities will broaden the yuan's trading band tenfold to 3 per cent, which will allow the yuan to appreciate 1.5 per cent," investment bank JP Morgan said in a report.
"JP Morgan expects a further 5 per cent yuan appreciation by the end of 2005 and total appreciation of 10 per cent within 12 months."
After Wednesday's reforms, the Australian dollar can be directly tradeable with the yuan, through interbank dealings with seven authorised foreign banks.
The yuan currently can be traded only against the $US, the Hong Kong dollar, the Japanese yen and the euro.
Westpac Bank economist Huw McKay said the dollar inclusion was not likely to have near-term implications for the dollar, but could reduce costs for Australian companies dealing with China. "It will reduce risk to importers by taking out third currencies," he said.
Mr McKay said most Sino-Australian trading was in $US-dominated resources, such as iron ore and coal. "But, as we export more sophisticated goods ... we may well have the power in the relationship to say 'please pay us in Australian dollars'."
JP Morgan economist Stephen Walters agreed. "Convertibility won't open the drawbridge but it might make things a little bit easier," he said. "The real impact is when China revalues its currency."
But economists said the Chinese were unlikely to move on a revaluation this week, despite the X-factor of surprise.
"My guess is it will be some time in the next three months," Dr Oliver said.
Mr McKay warned that such a move would weaken China's banking system, which relies on a vast pool of captive local savings.
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