China: Surprise Currency Boost Surprise After Weak Growth Figures

China has once again shown a capacity to surprise the west just when you don't expect major policy moves to happen.

At the end of a week of mixed economic reports, culminating in the surprisingly low annual growth rate of 8.1% for the first quarter, plus continuing evidence of political instability, the country's central bank sprang a major surprise on Saturday.

The People's Bank of China said that from today it will double the trading band, so that the Yuan can fluctuate by 1% every day from a mid-point, compared with its previous limit of 0.5%.

That is was a move from a central bank (and government), determined to push ahead with major economic reforms, rather than retreat or refuse to move in the last months of its life, and at a time of raised political tension at the top of the government.

It also tells us that China is ignoring the slowdown evident in the economy to push a major reform.

For these reasons it is an important decision for countries like Australia which depend on China as a major export partner.

It illustrates that the government believes the Yuan is now stable enough to handle major structural reforms, despite the slowing rate of growth of the Chinese economy.

The fact that this dramatic change has happened at this time of instability at the top of the government and the Communist Party in the wake of the purging of Bo Xilai and his wife (both well connected 'princelings') and the reinvestigation of the mysterious death of a British man late last year, tells us that the current leadership believes the crisis has been controlled.

Bo was the leader of a group of Chinese leaders, followers, media, the armed forces and others in the party who wanted a return to Maoist policies of greater state control and less liberalisation of the economy.

Greater freedom for the currency to rise and fall is seen as a major relaxation of central control over the economy and as such would have been objected to by the Maoist group.

It is also a sign of the confidence the current leadership has in its last months that it can make such an important move and attempt to neutralise any criticism from the west at this week's meetings of the G20 finance ministers and IMF in Washington.

Such a move would have been seen by the Maoists as 'appeasing' the west and a sign of weakness, which would have stopped it happening before Bo was purged.

The economy's slowdown seems to have allowed Beijing room to make the change, because the Chinese government knew it could introduce the larger band without causing a spike in the Yuan's value and it can also point to the rapidly shrinking trade surplus to bolster its case with western critics, especially in the US.

China's foreign reserves stand at $US3.18 trillion and are another source of tension, but don't be surprised if that figure starts falling slowly as the year goes on, to become another point the government can use to deflect foreign critics.

The trading band was last widened in May 2007 from a daily limit of 0.3% appreciation or depreciation to the old 0.5%. It was then fixed for nearly two years during the GFC.

Unlike at the last widening, the latest move is not seen as a sign that China will allow faster appreciation of its currency in the coming months.

Instead it will allow the currency to move in wider ranges as demand and supply play a greater role in determining its value (i.e., allow the market to have a greater influence, which would have been rejected by the Maoists).

Officials from the government, think tanks and advisors to the central bank have started making more comments in recent months in allowing the currency to have more flexibility.

But no one expected such a dramatic move would come so soon and at the present time with the political problems dominating the government in the final months of the current leadership.

Pressure on China's currency to appreciate has diminished in the past six to nine months as the trade surplus and capital inflows have shrunk.

The announcement came a month after PBOC governor Zhou Xiaochuan told Xinhua on the sidelines of the annual parliamentary session that the country is considering "appropriately" widening the Yuan's trading band to better reflect an exchange rate regime decided by market supply and demand.

Another interesting point was that The People's Bank of China took the unusual step of issuing its announcement in English rather than Mandarin, a sign it wanted the message out to the world as quickly as possible, with no possibility of it being wrongly translated.

The central bank explained the move was being made:

"In order to meet market demands, promote price discovery, enhance the flexibility of RMB exchange rate in both directions, further improve the managed floating RMB exchange rate regime based on market supply and demand with reference to a basket of currencies, the People's Bank of China has decided to enlarge the floating band of RMB's trading prices against the US dollar".

That's quite a change of heart for the Chinese government.

Meanwhile, Friday's first quarter growth data grabbed the headlines, making some offshore analysts worried, but leaving others more sanguine.

According the National Bureau of Statistics, the March quarter saw China's economy grow at its slowest rate in nearly three years.

The country's annual rate of GDP growth slowed to 8.1% from 8.9% in the previous three months, marking the fifth consecutive quarter of slowing growth in China.

China's economy expanded by 9.2% in 2011, its lowest rate for two years.

Quarter-on-quarter growth of GDP in each quarter of 2011 and in the first quarter of 2012 illustrates the slowdown in growth.

The March quarter of 2011 saw growth up 2.2% on the December 2010 quarter.

In the June quarter of last year, growth was 2.3%, then 2.4% in the September quarter, then 1.9% in the December quarter and 1.8% in the three months to March this year.

But analysts said there was enough in the data and other reports last week to suggest the Chinese slowdown was at or near the bottom and that growth would slowly rise towards the end of the year.

In March, industrial value-added output grew 11.9% year-on-year, higher than the 11.4% recorded in the first two months. Retail sales grew 15.2%, an increase from the 14.7% rate in January to February.

Car sales rose in March and the quarter.

Fixed asset investment rose 20.9% year-on-year in the first quarter, dropping 0.6 % from the January to February period.

But its real growth after deducting price factors still exceeded that registered during the January to February period.

New banking lending jumped unexpectedly last month and the AMP's chief economist, Dr Shane Oliver says that and "money supply growth rose consistent with signs that monetary conditions were eased in March which should also be supportive of growth going forward".

"While Chinese inflation ticked up in March, this followed a bigger than expected fall in February, and was mainly driven by higher food prices with non-food inflation remaining very low.

"As such it is not an impediment to further gradual monetary easing.

"To top it off the Chinese share market increasingly looks like it is trying to build a base and has started to rally again before falling back to January lows (and for technicians looks like it's forming an inverse head and shoulders)."

"If it is bottoming and confidence starts to build that China is having a soft landing this would be very positive for Asian and emerging market shares. It is also a positive sign for the Australian share market, particularly with the RBA edging towards more interest rate cuts," he wrote at the weekend.