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Cablegate: Has China Changed Its Exchange Rate Policy?

VZCZCXRO2290
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #4481/01 3442343
ZNR UUUUU ZZH
P 092343Z DEC 08
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 1294
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 02 BEIJING 004481

SIPDIS
SENSITIVE

STATE FOR EAP/CM AND E/YON
TREASURY FOR OASIA/DOHNER/WINSHIP/CUSHMAN
TREASURY ALSO FOR IMFP/SOBEL/MOGHTADER
NSC FOR LOI

E.O. 12958: N/A
TAGS: ECON EFIN CH
SUBJECT: HAS CHINA CHANGED ITS EXCHANGE RATE POLICY?

THIS CABLE IS SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET
DISTRIBUTION.

1. (SBU) Summary. Since December 1, the Chinese renminbi
(RMB) has depreciated 0.7 percent against the USD,
generating speculation that the government has altered itQs
longstanding policy of gradual appreciation. Senior
economic and financial leaders, however, continue to
maintain that policy has not changed, but that exchange
rate fluctuations must be expected. They also have
acknowledged that the exchange rate issue is complicated,
requiring a balancing of various social, political, and
economic concerns, including how best to assist the
distressed export sector. Most analysts expect further
appreciation of the RMB against the USD will be limited in
the near term. See paragraphs 7-8 for comments. End
summary.

2. (SBU) The recent slight depreciation of the Chinese
renminbi (RMB) against the USD has raised questions about
whether China has revised its exchange rate policy. Over
the past week (Dec. 1-8), the RMB depreciated 0.7 percent
against the USD. More specifically, during the six trading
days from Dec. 1-8, the RMB depreciated each day by 0.4-0.5
percent (the band limit) in intra-day; after each dayQs
depreciation, the PeopleQs Bank of China (PBOC) set the
following dayQs morning reference rate 0.4-0.5 percent
higher. In response, various rumors and speculation have
begun to appear: China is delivering a warning to the
United States Government in advance of the Strategic
Economic Dialogue and/or Qsending a signalQ to President-
elect Obama (one currency trader claims to have been told
by the PBOC that the Dec. 1 depreciation was intended to
send a message to the incoming Obama administration), or
China wants to reassure its exporters that their government
is responsive to their plight.

3. (SBU) Officially, the Chinese Government insists there
has been no change of policy. At the December 4-5
Strategic Economic Dialogue (SED) meetings, Vice Premier
Wang Qishan stated that the United States can Qrest assured
that the Chinese government will not go back on its word
(on currency policy).Q Commerce Minister Chen Deming said
the RMBQs slight weakening reflected the USDQs strength and
had been decided by the market. Chen also said China was
Qnot counting onQ the falling value of the RMB to help its
exporters. Similarly, a December 8 Hong Kong press report
quoted remarks by Wang that the recent RMB depreciation was
due to market-led technological adjustment and revision
(perhaps referring to investors adjustment of their
portfolios following the Chinese central bankQs 108 basis
point reduction in administered interest rates), and was
not a deliberate government intervention.

4. (SBU) These comments are consistent with those made by
other senior economic policy officials over the past two
months. On December 3, visiting U.S. Federal Reserve Board
Governor Kevin Warsh asked PBOC Vice Governor Yi Gang if
the previous four consecutive days of RMB depreciation
against the USD meant a change in policy; Yi replied that
in the second half of 2008, the RMB-USD rate had been
Qbasically stable,Q but the strong USD had caused the RMB
to appreciate significantly against other major currencies.
Yi told Warsh that the QUnited States should not worryQ and
there has been no change in exchange rate policy, and that
increasing fluctuations in either direction were Qperfectly
normal,Q and to be expected as China moved to a currency
policy more reflective of market supply and demand. Yi
said China remains committed to the goal of a convertible
currency, but in the short-term the rate will remain
QbasicallyQ stable.

5. (SBU) Despite official assurances, ChinaQs exchange rate
policy remains a focus of intense internal debate. On
November 7, Vice Minister Liu He of the Central Leading
Group on Financial and Economic Affairs told TreasuryQs
Special Envoy Alan Holmer that the exchange rate is a
Qcomplicated issue.Q Officials in eastern provinces, SMEs
and workers in the export sector are QangryQ with the
central government for letting the RMB rise against the US
dollar. Liu said further RMB strengthening against the USD
was not possible in the short-term as it would lead to
unrest in those sectors. Similarly, on October 20 PBOC
Governor Zhou Xiaochuan told Treasury Under Secretary David
McCormick that this issue was not simple for ChinaQs top

BEIJING 00004481 002 OF 002


leadership. The State Council felt pressure to signal
support for the export sector by limiting appreciation of
the RMB. Zhou added that periodic pauses in the pace of
RMB appreciation should not be a concern to the U.S. as
long as the long-term trajectory remained the same.

6. Most market analysts expect RMB appreciation against
the US dollar to be limited in the near-term. Most, but
not all, analysts do not believe this weekQs depreciation
signals a fundamental shift in policy towards depreciation,
given that they believe Chinese officials continue to
support a gradual reduction in ChinaQs large balance of
payment surplus; they also believe the government is
sensitive to the risks that a depreciation of the RMB, in
the context of continued large-scale intervention in
foreign currency markets, risks unleashing a protectionist
backlash. Another analyst suggests that, regardless of
what PBoC intends to do, if the traders think they intend
to depreciate the RMB, then it will come under downward
pressure.

7. (SBU) Comment: We agree with most market analysts that
this weekQs developments most likely do not represent a
fundamental shift in the long-standing policy of gradually
appreciating and increasing the volatility of the RMB
against the USD, with occasional QreferenceQ to a trade-
weighted basket. We interpret the QreferenceQ to a basket
as accelerating (slowing) the pace of RMB appreciation
during periods of US dollar weakness (strength). We think
the most likely reasons for the RMBQs depreciation this
week are: 1) the desire of officials of the PeopleQs Bank
of China - which only implements and does not determine
monetary and exchange rate policies, and unlike the Federal
Reserve is not politically independent - to demonstrate
that they are sensitive to the difficulties facing Chinese
exporters (amid press reports that export growth dropped
significantly in November); and 2) investors exiting the
Qcarry-tradeQ of shorting the U.S. dollar given narrowing
interest rate differentials.

8. (SBU) Comment, continued. That said, if the U.S.
dollar appreciates significantly against other major
currencies or the Chinese authorities perceive a rising
risk of deflation, the chances that exchange policy will
change in favor of sustained depreciation of the RMB
against the U.S. dollar increases significantly. Many
Chinese firms face excess capacity in the face of rapidly
weakening demand (particularly abroad), and the pass
through to inflation of changes in the exchange rate of the
RMB to the U.S. dollar is relatively high. Liu He told
Federal Reserve Governor Kroszner that inflation is no
longer a concern, and that while deflation is not yet a
concern, government officials will be watching for signs of
this in the coming year.

PICCUTA

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