China and Renminbi

It was China's turn to answer back to last weekend's G7 meeting of finance ministers urging Beijing to end its currency peg to the US dollar.

Wei Benhua, the deputy director of the State Administration of Foreign Exchange said that China will "positively," but prudently, accelerate the process of reform of the renminbi (RMB) exchange rate.

His comments came one day after China's central bank Governor Zhou Xiaochuan said that Beijing needed to take into consideration the overall impact on trade with its trading partners and neighboring countries rather than solely looking at bilateral trade balances.

Wei also remarked that complete liberalization of the currency market may take "several decades" and that China is half way into reaching that point.

China will not succumb to external pressure and compromise its economic engine for the sake of prematurely liberalizing its financial markets.

China will have to follow up on last year's rate hike so as to contain inflation at its implicit 5% target and to avoid policy over-stimulus. Only a successfully implemented revaluation -- likely in Q1 2006 -- could then lead to a subsequent 2-3% upward move with a similar band, thus creating a crawling peg currency regime, i.e. periodic revaluations thereafter.

This would pave the way towards an eventual basket peg, whereby the yuan is pegged against the dollar, euro, yen, Aussie and a few other Asian currencies.

Such an arrangement would be ideal for avoiding sudden fluctuations, which are more typical of single currency pegs, especially with China's disparate trade balances against the currencies involved.