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China’s signal of an end to the yuan’s fixed rate to the dollar may accelerate a shift toward domestic demand as the prime driver of growth as President Hu Jintao seeks to strengthen household incomes.

The People’s Bank of China two days ago indicated it’s abandoning the 6.83 yuan peg to the dollar adopted during the global crisis to shield exporters. The central bank said while there’s no basis for “large scale” moves in the currency, the exchange rate will be allowed increased “flexibility.”

A stronger yuan will boost the purchasing power of China’s households that have helped propel imports to a record level, and companies from Orient Paper Inc. to Air China Ltd. that purchase goods from overseas. The lift adds to trends already under way that are stoking wages, as workers demand higher paychecks from employers including Honda Motor Co.

“Over a longer time, today’s announcement opens the door for increased yuan appreciation that will help adjust China’s economy towards a consumption-driven economy,” said Ma Jun, chief China economist at Deutsche Bank AG in Hong Kong, who is a former researcher for China’s State Council, or Cabinet, and used to work at the International Monetary Fund.

The Chinese central bank made its announcement at 7 p.m. Beijing time on June 19 in a posting on its website, a week before leaders from the Group of 20 meet in Toronto.

Economic Restructuring

The PBOC said in a follow-up statement yesterday that a more flexible currency will “direct resources to domestic-demand driven sectors such as services” and help curb an excessive reliance on exports, signaling it anticipates the currency will rise. It advanced 0.2 percent to 6.81 as of 11:30 a.m. in Shanghai, the most since December 2008.

“This is a catalyst for change” because exporters will be forced to speed productivity gains, while rising incomes will stoke the retail industry, said Jing Ulrich, chairwoman of China equities and commodities at JPMorgan Chase & Co., in an interview with Bloomberg Television.

Ulrich said domestic consumption stocks, such as Li Ning Co., a Beijing-based sports-shoe and clothing maker, China Dongxiang (Group) Co., a sportswear-apparel retailer and Beijing-based department-store chain Parkson Retail Group Ltd. will benefit. “Renminbi-based assets should be worth a lot more in U.S. dollars a few years down the road.”

Managed Float

Authorities will resume a managed float of the yuan, also known as the renminbi, against a basket of currencies, according to the June 19 statement. Before the exchange rate was frozen in July 2008, Premier Wen Jiabao’s government had allowed a 21 percent advance versus the dollar over three years.

While the International Monetary Fund reaffirmed its view that the currency is “substantially” undervalued, analysts at banks from Goldman Sachs Group Inc. to Royal Bank of Scotland Group Plc predicted gains in the coming year will be held to less than 6 percent. The median of 14 forecasts in a Bloomberg News survey indicates a rise to 6.7 by Dec. 31.

The small move anticipated in coming months means there will be limited impact on the economy in the short term, said Ma at Deutsche Bank. At the same time, exchange-rate strengthening will likely over time lead to greater household purchasing power, according to the Washington-based IMF, which conducts annual reviews of its member economies.

Inflation Aid

Yuan flexibility may damp inflation, John Lipsky, the fund’s No. 2 official, said in a Bloomberg Television interview. Consumer prices rose 3.1 percent in May from a year before, exceeding the government’s 3 percent target average for 2010.

“It’s a win-win for China,” Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics in Washington, said on Bloomberg Television. It may ease trade tensions, while also supporting “the structural adjustment that they’ve wanted now for several years -- less investment going into the export sector, more to satisfy domestic demand.”

A stronger currency will benefit Chinese paper makers as the costs of pulp imports will drop. That’s particularly true as exports aren’t an important part of the business, according to Winston Yen, chief financial officer for Hebei, China-based Orient Paper, speaking in April.

It would also be a boon to China Southern Airlines Co., China Eastern Airlines Corp. and Air China by cutting dollar- denominated fuel bills and the cost of debt payments for purchases of Boeing Co. and Airbus SAS planes, according to Ally Ma, an analyst at Citigroup Inc. in Hong Kong.

Accelerating Growth

The yuan decision follows a strengthening in China’s economy that saw gross domestic product expand 11.9 percent in the first quarter from the same period of 2009. Surging industrial production, exports, retail sales and property prices have sparked concern of an overheating that may end in a bust.

U.S. Treasury Secretary Timothy F. Geithner had advocated yuan flexibility as a means of addressing China’s price pressures, outside of the argument of American lawmakers that the yuan peg was an unfair subsidy for China’s exporters.

In an indication of confidence in the U.S., China increased holdings of Treasury notes and bonds by 2.6 percent to $900.2 billion in April from the previous month, after reducing its stake by 6.5 percent from November through March, according to U.S. data released June 15.

China’s leaders are aiming to buttress domestic incomes and reduce reliance on exports that collapsed during the crisis, culminating in a record 26 percent drop in shipments in May 2009 from a year earlier.

No ‘Panacea’

A more flexible yuan “is not a panacea” for global trade imbalances, Stephen Roach, chairman of Morgan Stanley Asia Ltd., said in an e-mail. Countries with large savings, such as China, “still need to take additional actions to stimulate internal private consumption,” he said.

In the past 10 years, China’s economy became more unbalanced, with consumption’s share of GDP falling to 35 percent last year from 45 percent in 2000, according to Societe Generale SA. Now, a rebalancing “seems to be occurring by default” as labor shortages in coastal provinces encourage wage gains that will boost consumer spending, Glenn Maguire, a Hong Kong-based economist for the bank, said in a report last week.

“Consumer spending won’t see significant advances unless the government effectively reduces people’s precautionary savings for education, health care and old age,” said Liu Li-Gang, a Hong Kong-based economist at Australia and New Zealand Banking Group Ltd.

Regional Development

The State Council earlier this month approved a program to map out development strategies for each of the nation’s regions, the official Xinhua news agency reported June 12. President Hu plans to convene a meeting to discuss how to narrow the income gap later in the year, the Hong Kong-based newspaper South China Morning Post reported over the weekend.

More than 20 provinces and cities have overseen increases in minimum wages in recent months to help support incomes, and a focus of the 4 trillion yuan ($586 billion) stimulus package on boosting inland regions has helped reduce reliance on the export-linked coast.

Manufacturers including Ningbo-based Dejin Textile Co., Shanghai-based China Crown Textile Co. and Shenzhen Jufeng Handicraft Co. have said the development of internal regions, such as Chongqing, has made it harder for them to attract migrant workers to factories on the east coast.

Meantime, employees in foreign-owned plants have been demanding higher compensation. Honda, Japan’s No. 2 carmaker, raised pay by 24 percent at a parts-making factory in Foshan, Guangdong province, after a strike crippled its production in China. Labor unrest then spread to Toyota Motor Corp.

Monetary Policy

At the same time as seeking to strengthen household incomes, China’s leaders have been pulling back on monetary stimulus in an effort to stem asset-price inflation. Data on June 10 showed property prices rose at a near-record pace, with costs jumping 12.4 percent across 70 cities from a year earlier.

The move to allow a stronger yuan means authorities may not need to tighten domestic monetary policy as much as previously was the case, according to Morgan Stanley.

Wang Qing, Greater China economist at Morgan Stanley in Hong Kong, wrote in a note that the PBOC likely won’t raise interest rates this year. He also said the government may raise its target for 2010 credit growth from 7.5 trillion yuan. A record 9.59 trillion yuan of new loans were signed last year.

“The Chinese are increasingly confident they can make this adjustment to a domestic-driven economy rather than the one relying on exporting low-value-added stuff to the rest of the world,” Jim O’Neill, chief global economist at Goldman, said in an interview with Bloomberg Television in St. Petersburg, Russia, after the PBOC statement.

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