China to Widen Yuan Trading Band against Dollar

China's central bank said it would widen the Yuan’s trading band against the dollar, loosening currency controls in a major step towards adopting more market-oriented reforms.

The Yuan is currently allowed to trade 0.5 percent on either side of a midpoint price set by the central bank every trading day.

The new rules will come into effect on Monday and allow the currency to fluctuate by up to 1.0 percent either side, the bank said in a statement.

Beijing's trading partners have long criticized its Yuan exchange rate, saying it is kept artificially low, fuelling a flow of cheap exports that have helped trigger huge trade deficits between some countries and China.

However, that pressure has eased since data this year showed China's trade balance with the rest of the world has shifted, ending a long period of huge trade surpluses based on low-cost labor and a cheap Yuan.

China has repeatedly vowed to loosen its grip on the Yuan as it moves towards full convertibility but it has rejected calls for a faster appreciation for fear of hurting its manufacturing sector, a key driver of its economy.

Saturday's announcement means that the Yuan will be allowed to fluctuate further against the dollar but not necessarily appreciate as much as China's trading partners, including the United States, might like.

The bank said the change was decided "in order to meet market demands... (and) enhance the flexibility of RMB (the renminbi, as the Yuan is officially known) exchange rate in both directions".

"In view of the domestic and international economic and financial conditions, the People's Bank of China will continue to fulfill its mandates in relation to the RMB exchange rate, keeping RMB exchange rate basically stable."

Wang Tao, an economist at UBS, said the band widening was not a surprise as the dollar-Yuan exchange rate was now close to fair value and the current account surplus was not excessive.

"It's a good time to increase the flexibility of the exchange rate," Wang said.

A Shanghai-based trader at a foreign bank added that "it shows that the authorities are confident that the Yuan has reached an equilibrium level and widening the band won't trigger too much volatility".

Ting Lu, China economist at Bank of America Merrill Lynch, said the move would ease international pressure to allow the Yuan to appreciate and was bigger than market expectations of a 0.7 percent trading band.

"External pressure for RMB-USD appreciation will be alleviated," he said in a note.

The announcement came after China said Friday its economy grew at its slowest pace in nearly three years in the first three months of 2012, expanding by 8.1 percent.

However, analysts predicted the world's second-largest economy would avoid a hard landing, which could trigger massive job losses and spark social unrest.

The central bank called in February for the government to move faster to loosen currency controls to make it easier for Chinese companies to invest overseas and boost the Yuan’s global status.

China restricts the movement of money outside the country such as investment in real estate, stocks and bonds to prevent sudden inflows and outflows of capital that could destabilize its financial system.

Beijing has vowed to increase the use of the Yuan in international trade and encourage foreign investment in Shanghai's financial markets, according to a five-year blueprint unveiled this year by the National Development and Reform Commission, a powerful state planner.

But in its study released in February, the central bank said reforms were taking too long and China could loosen investment controls and encourage more enterprises to take opportunities abroad in the next three years.