Yuan Declines Before Paulson Visit as China Supports Economy

By Judy Chen

Dec. 1 (Bloomberg) -- China’s yuan fell by the most in seven weeks, three days before U.S. Treasury Secretary Henry Paulson visits Beijing for trade talks, on speculation the central bank wants to weaken the currency to spur the economy.

The People’s Bank of China set its daily reference rate at the weakest level since August, after resisting pressure for the currency to appreciate since the end of July. Two reports showed China’s manufacturing contracted by a record last month as recessions in the U.S., Europe and Japan curbed demand for Chinese products.

China’s policy makers have shifted focus from stemming inflation to sustaining growth after the economy expanded at its weakest pace since 2003 in the third quarter. The yuan has gained 0.4 percent against the dollar since the two governments last held trade talks in mid June, after it advanced 6.6 percent in the first half of 2008.

“Today’s reference rate is totally unexpected,” said Yang Lindong, a foreign-exchange trader at Shenzhen Development Bank Co. in Shenzhen. “The central bank may want to test the market’s response to the possibility of a weaker yuan, but most likely it will keep the currency stable till the end of this year.”

The yuan slid 0.3 percent to 6.8570 a dollar, the weakest since Oct. 27, before trading at 6.8563 as of 2:24 p.m. in Shanghai, from 6.8349 late last week, according to the China Foreign Exchange Trade System. Today’s drop is the biggest since Oct. 10.

The central bank fixed the reference rate for yuan trading at 6.8505 today, the lowest since Aug. 21. The currency is allowed to trade by up to 0.5 percent against the dollar either side of the reference rate, which has stayed between 6.8240 and 6.8369 in October and November.

Paulson Talks

The fifth round of the U.S.-China Strategic Economic Dialogue will be in Beijing on Dec. 4 and 5 before President- elect Barack Obama’s inauguration next month. The previous round was in Annapolis, Maryland in mid-June. Obama on Oct. 24 called for an end to manipulation of the yuan.

“Paulson may call for more yuan gains, but certainly China will determine its exchange-rate policy based on economic fundamentals,” said Liu Dongliang, a Shenzhen-based foreign- exchange analyst at China Merchants Bank Co., the country’s sixth largest lender. “As the economy may deteriorate, risks of depreciation are piling up.”

The yuan has appreciated 21 percent since a peg against the dollar was scrapped in July 2005, making Chinese shipments less attractive and eroding exporters’ profits. Two-thirds of China’s small toy exporters shut down in the first nine months of this year, the customs bureau said in a report on Nov. 24.

Manufacturing Index

The Purchasing Managers’ Index fell to a seasonally adjusted 38.8 in November from 44.6 in October, the China Federation of Logistics and Purchasing said today in an e-mailed statement. Export orders, output and new orders all contracted by the most since the survey began in 2005. A survey conducted by CLSA Asia-Pacific Markets also showed a record contraction.

China’s economy, the world’s fourth largest, expanded 9 percent in the third quarter from a year earlier. The CSI 300 Index of stocks has fallen 69 percent from a record in October last year and President Hu Jintao describes the economic situation as a test of the Communist Party’s ability to govern.

Non-deliverable forwards contracts show traders are betting that the yuan will depreciate 4.9 percent to 7.2066 per dollar in a year, the weakest in more than one month.

Forwards are agreements in which assets are bought and sold at current prices for settlement at a later-specified time. Non- deliverable forwards are settled in dollars rather than the underlying asset.

Economists are more bullish on the currency later next year. The yuan will strengthen 2.3 percent to 6.7 by the end of 2009, according to a Bloomberg survey of 28 analysts. They forecast the currency will end this year at 6.81.

Short-Term Bonds Gain

China’s government bonds due in five years and less rose on speculation investors have more funds for debt investment after the central bank last week cut benchmark interest rates and lowered requirements on banks’ deposit reserves.

The People’s Bank reduced the one-year lending and deposit rates by 1.08 percentage points Nov. 26. The lending rate fell to 5.58 percent and the deposit rate to 2.52 percent. It also reduced the reserve ratio for major commercial banks by 1 percentage point, effective Dec. 5.

Bonds maturing in more than five years dropped on concerns their yields have little room for further declines.

“Investors are expecting liquidity will continue to increase later this year after the rate cut last week, driving up the demand for short-term debt,” said He Xiuhong, a fixed- income analyst at GF Securities Co. in Guangzhou, the nation’s third-largest brokerage by revenue. “By contrast, people are more cautious about bonds with long maturities as there are more uncertainties in the longer run.”

The yield on the 3.34 percent note due September 2009 dropped 1.1 basis point to 1.8 percent, according to the China Interbank Bond Market. The price of the security rose to 101.15 per 100 yuan face amount.

To contact the reporters on this story: Judy Chen in Shanghai at xchen45@bloomberg.net