Yuan heading for high 'five' as trade surplus increases

A gaping trade surplus pushed the renminbi to a new record high at the central bank fixing on Tuesday, and analysts said that the currency is headed for "five" territory for the first time next year.

The People's Bank of China, the central bank, set the yuan's daily reference rate 16 basis points higher at 6.1114 per dollar, the highest since China revamped its foreign exchange regime 20 years ago.

The yuan has advanced 2.6 percent against the dollar so far this year, making it the best-performing Asian currency and extending its gain to 36 percent since 2005.

"The central bank faces a dilemma. It's almost sure that the dollar-yuan exchange rate will start with 'five' some day in 2014," said Zhou Hao, an economist with Australia and New Zealand Bank Group Ltd.

The central bank is in a tight spot, because there will be negative consequences whichever way it guides the currency, he explained.

A higher exchange rate helps keep domestic liquidity tight by blocking fund inflows, but it hurts exports. A lower rate benefits exports, but it draws in more funds, which forces the central bank to release liquidity.

China reported its widest trade surplus in almost five years on Sunday. The surplus rose to $33.8 billion in November from $31.1 billion the month before. Exports jumped 12.7 percent, well ahead of October's 5.6 percent growth. Imports rose a more modest 5.3 percent.

The surplus with the United States alone was $22.4 billion in November.

Zhou said that part of the growth in the export figure in November resulted from speculative funds, or hot money, in the guise of normal trade. That's because data on industrial activity in the month doesn't correspond with the reported jump in overseas shipments, he said.

Industrial production growth actually decelerated in November to 10 percent year-on-year, down 0.3 percentage point from October, according to the National Bureau of Statistics.

Lu Zhengwei, chief economist with Industrial Bank Co Ltd, agreed with Zhou, interpreting the central bank's Dec 6 decision to crack down on fake trade financing as proof that the import jump was "problematic".

The PBOC would get some relief if the US Federal Reserve Board raised interest rates, but economists don't see that happening anytime soon, despite talk that the Fed will end its policy of quantitative easing.

Russ Koesterich, global chief investment strategist with BlackRock Inc, the world's biggest money manager, said in a research note on Tuesday that while it is still possible the Fed will announce tapering of its bond purchases this month, he still feels early 2014 is a more likely timeframe, as economic growth in the US will remain modest.

It's widely believed that the Fed will increase interest rates one to two years after it ends QE, and that will erase the incentive for funds to flow into China for higher interest rates.

China has also been pursuing interest rate liberalization, which will reset interest rate levels in the country. The PBOC said over the weekend that it will allow lenders to issue negotiable certificates of deposit, with rates based on interbank rates in Shanghai.

The CDs "are an important step in preparing banks for further liberalization of client deposits rates," Dariusz Kowalczyk, a Hong Kong-based economist at Credit Agricole CIB, wrote in a research note on Tuesday.