Yuan's Advance This Year Matches Gains for All 2007; Bonds Rise

By Judy Chen and Kim Kyoungwha

July 11 (Bloomberg) -- The yuan's advance this year matched its gains for all of 2007 as China pledged to maintain efforts to strengthen the currency to stem inflation and narrow the trade surplus. Bonds rose.

The local currency climbed to the highest since authorities abandoned a dollar link in July 2005 as U.S. Treasury Secretary Henry Paulson yesterday urged China to accelerate the yuan's appreciation that is ``a key'' to the country's economic progress. The yuan rose 2.5 percent in the past three months, the best performance among the 10 most-active currencies in Asia outside Japan, as Premier Wen Jiabao reaffirmed in July that the battle against inflation remains his government's top priority.

``Inflation is still a huge issue,'' said Naomi Fink, a Tokyo-based senior currency strategist at Bank of Tokyo- Mitsubishi UFJ Ltd. ``China cannot afford to support exports by stopping the yuan rise. The dollar's strength would only aggravate already existing inflationary pressure.''

The yuan strengthened 0.34 percent this week to 6.8359 a dollar as of 3:05 p.m. in Shanghai, from 6.8589 on July 4, according to the China Foreign Exchange Trade System. It touched 6.8352 today, the strongest since the end of the dollar peg, increasing this year's gain to 6.86 percent this year.

Quicker Inflation

Inflation accelerated to 8.1 percent in the first five months of the year, from 4.8 percent for all of 2007, posing a threat to economic stability as the nation prepares to host the Olympics next month. The strengthening of the yuan has helped lower import costs as oil prices reached a record $145.85 a barrel on July 3 and narrow a record trade surplus that has flooded the economy with cash.

The June trade surplus narrowed 21 percent to $21.4 billion from a year earlier, the customs bureau said yesterday. The yuan is ``obviously substantially undervalued,'' Dominique Strauss- Kahn, managing director of the International Monetary Fund, said on July 9.

``Solid export growth and the still-large trade surplus should support a stronger effective yuan exchange rate going forward,'' Song Yu, an economist at Goldman Sachs Group Inc. in Hong Kong, said in a report yesterday.

The Westpac Nominal Effective Exchange Rate, a trade- weighted index for the yuan, has climbed 6 percent this year, almost double the 3.4 percent gain last year.

`Biggest Challenge'

``The biggest challenge for the central bank is to deter bets on yuan gains while allowing its steady appreciation,'' said Liu Dongliang, a foreign-exchange analyst in Shenzhen at China Merchants Bank Co., the country's sixth largest lender. ``Wider fluctuations would keep some hot money out of the country by raising speculators' transaction costs.''

Liu said the currency won't rise more than 5 percent versus the dollar in the second half of this year.

In its efforts to tighten controls on speculative capital, the State Administration of Foreign Exchange, said July 2 that it will require exporters to deposit foreign-currency income, including prepayments, into designated bank accounts from July 14 before the currency regulator confirms authenticity of the revenue and allows it to be converted.

``Exporters are hurrying to repatriate earnings from overseas and convert the money to the yuan before the start of the new rules, which boosted the demand for the local currency in the past two days,'' said Liu Hantao, a foreign-exchange trader at China Construction Bank Corp. in Beijing.

Bonds Advance

One-year non-deliverable forward contracts show traders are betting on a 5.7 percent advance in the yuan to 6.465 in the next 12 months. The currency will reach 6.65 per dollar by year- end, according to the median estimate of 27 analysts surveyed by Bloomberg News.

Forwards are agreements in which assets are bought and sold at current prices for delivery at a later specified time and date. Non-deliverable contracts are commonly used for currencies that aren't freely convertible and are settled in dollars.

Local-currency bonds rose after the finance ministry sold debt at a lower-than-expected yield today. The government sold at least 24 billion yuan ($3.5 billion) of three-year bonds at a yield of 3.92 percent, compared with 3.95 percent traders expected, said Nie Shuguang, a fixed-income trader at Industrial Bank Co. in Shanghai.

The yield on the 4 percent note due in October 2012 fell 10 basis points to 4.05 percent, according to the China Interbank Bond Market. The price climbed to 99.79 from 99.41. A basis point is 0.01 percentage point.

To contact the reporters on this story: Judy Chen in Shanghai at xchen45@bloomberg.net; Kim Kyoungwha in Beijing at kkim19@bloomberg.net.