Chinese currency to strengthen next year

The Renminbi, or yuan, is likely to strengthen to 6 or below against the U.S. dollar next year with the economy back on its feet.

Data from the central bank show the yuan rising from 6.2386 against the U.S. dollar at the beginning of the year to 6.1305 on November 20, a new high since July 2005 when the exchange rate mechanism was overhauled.

The strength comes from a firming economy at home and a new round of capital inflow brought by expectations of yuan appreciation, the China Securities Journal analyzed Thursday.

There was a huge accumulation of foreign exchange reserves by the central bank in October. Boosted by good news at home, foreign exchange reserves may continue to increase, said Lian Ping, chief economist at Bank of Communications.

Wen Bin, senior analyst with the Bank of China, expects faster yuan appreciation in the near future. Appreciation of the yuan has brought capital inflows, but the trade surplus is no longer the main cause. Wen believes that capital inflow itself is now a driving force.

With China now exporting capital instead of goods, yuan appreciation becomes more acceptable. As new policy encourages domestic enterprises and financial institutions to venture forth, a strong yuan will sharpen the competitive edge of Chinese companies.

Capital demand from Africa for infrastructure remains high. Chinese capital, facilities and technology could be a good choice for many countries to save on costs and gain development expertise. In this way, China will be more involved in international economic activities, the China Securities Journal said.

The exchange rate formation mechanism also needs a shake up. The central parity system needs to mirror the market. Zhou Xiaochuan, governor of the People's Bank of China (PBOC). wrote in a recent book about reform that to make the currency flexible and market-driven.

He argues that China must expand the yuan's foreign exchange trading band. For a better market role, the central bank will establish a managed, floating exchange rate system based on supply and demand.

The anticipated yuan appreciation will bring trade and motivate capital inflow, said Liu Yuhui, an economist at the Chinese Academy of Social Sciences. Exchange rate flexibility relies on macroscopic conditions and may improve if macroscopic conditions change, he said.

The yuan exchange rate depends on the environment both at home and abroad. A dovish global standpoint on quantitative easing coupled with medium to high domestic growth will also strengthen the yuan.

Uncertainties still exist, nonetheless, as capital might flow out again with the opening of the capital account, Wen said.