`Hot Money' Crackdown Means Slower Yuan, Yu Says

By Kim Kyoungwha and Kevin Hamlin

Aug. 1 (Bloomberg) -- China's crackdown on ``hot money'' seems to be curbing inflows of speculative capital, enabling policy makers to slow the pace of yuan appreciation, said Yu Yongding, a former adviser to the central bank.

More rigorous checks by the State Administration of Foreign Exchange, China's currency regulator, have started to control ``unwanted money'' flows, reducing the need for rapid yuan appreciation to quell inflation, Yu said. China last month set up an electronic network to monitor export income to stop speculators using bogus contracts to bypass investment rules.

``If capital controls are effective then we have more freedom to go slower'' on the yuan, Yu said in an interview in Beijing today. ``Without effective capital controls you have to allow the yuan to appreciate as quickly as possible otherwise there could be huge capital inflows that will worsen inflation.''

A record trade surplus and investors seeking to profit from appreciation in the yuan has flooded China's economy with cash, pushing currency reserves to $1.8 trillion and helping drive up consumer prices. The inflation rate was 7.1 percent in June, after reaching a 12-year high of 8.7 percent in February.

The commerce ministry is pressing for slower yuan gains to protect exporters after the currency's 6.8 percent advance against the dollar this year, which is on par with the 7 percent pace for 2007. Traders of forward yuan contracts have pared bets on the speed of the yuan's gain over the next year.

Announcements by China's Communist Party last week dropped any mention of ``tight monetary policy'' that appeared in previous statements and said maintaining economic growth was an equal priority along with fighting inflation.

Forward Bets

The yuan traded at 6.8405 per dollar as of 2:20 p.m. in Shanghai, according to the China Foreign Exchange Trade System. It headed for the biggest weekly loss since a link to the dollar was scrapped in July 2005 after advancing the least in July since March last year. The Chinese currency is 21 percent higher than the 8.3 level it was pegged at.

Non-deliverable forwards contracts show an implied rate for the yuan over the next 12 months of 6.5432, a rise of 4.5 percent from today's spot-market rate, and compared with bets for a level of 6.4445 at the end of June. The currency will trade at 6.40 to the dollar by the end of the second quarter, according to a Bloomberg News survey of 21 economists and analysts.

Forwards are agreements in which assets are bought and sold at current prices for future delivery. Yuan forwards are non- deliverable because they are settled in dollars rather than the local currency.

`No Backtracking'

China shouldn't slow the yuan's gains too much, said Yu, now a professor at the Institute of World Economics & Politics at the Chinese Academy of Social Sciences. The appreciation should be fast enough to pressure enterprises to move out of low-end manufacturing and into higher value-added products, he said.

``There should be no backtracking,'' he said. ``This would be harmful for China's long-term sustainable development.''

Manufacturing contracted for the first time since a survey began in 2005 as export demand faltered and factories closed before the Olympic Games, the China Federation of Logistics and Purchasing said today in an e-mailed statement. The economy expanded at the slowest rate since 2005 in the second quarter.

``To slowdown the growth rate of the economy will provide an environment for companies to make adjustments,'' Yu said. The policy tweak showed a government that is responsive to the voices of manufacturers and provincial leaders, he said.

To contact the reporters on this story: Kim Kyoungwha in Beijing at kkim19@bloomberg.net; Kevin Hamlin in Beijing on 2317 or khamlin@bloomberg.net