BEIJING – China bowed to months of market and political pressure on Thursday by revaluing the yuan by 2.1 percent and abandoning the currency's decade-old peg against the dollar.
In a long-awaited move that it said would improve the running of the economy and give more play to market forces, the central bank said the yuan's value from now on would be linked to a basket of currencies of China's main trading partners.
Beijing had been under strong pressure from its trading partners, especially the United States, to abandon the yuan's peg of 8.28 per dollar, which they said undervalued the currency and handed Chinese exporters an unfair advantage on world markets.
The new rate, initially, will be 8.11 yuan per dollar, well short of the 10 percent revaluation that Washington had been seeking to head off protectionist pressure in Congress.
The central bank said the yuan, also known as the renminbi (search) (RMB), would be allowed to move in a tight range of 0.3 percent up or down from the previous day's close in a continuation of the "managed float" policy in place 1994.
"The People's Bank of China (search) will make adjustment of the RMB exchange rate band when necessary according to market development as well as the economic and financial situation," the central bank said in a statement in English on its web site.
"The RMB exchange rate will be more flexible based on market conditions with reference to a basket of currencies," it said.
U.S. Treasury Secretary John Snow (search) welcomed China's move as a step toward a more stable world economy.
"They've put in place a mechanism that provides room for significant movement over time in the currency, and they've expressed a commitment to using market forces to let the currency move," Snow told a news conference. "I think today's developments are extremely positive."
Snow said China's decision to drop the yuan's peg to the dollar and tie it to an unspecified basket of currencies established "significant amplitude" for the currency to move further in future.
"It's very encouraging," the Treasury chief said in an interview on CNBC television. "This is an important step in the right direction for the global economy."
Snow said the United States was heartened by Chinese statements suggesting there may be room for the yuan's value to shift gradually toward a market-set rate.
"I particularly noted China's objective of allowing the market to fully play its role in resource allocation as well as 'to put in place and further strengthen the managed floating exchange regime based on market supply and demand,"' he said.
In theory, a managed float leaves open the possibility of further incremental revaluations. But in practice China has kept the yuan virtually fixed; since early 1998 it has traded in a wafer-thin range near 8.28 per dollar.
"It was going to happen at some point. They have introduced a very modest appreciation to kick the whole thing off," said Ian Gunner, head of foreign exchange research at Mellon Financial Corp. in London.
The big question for dealers was whether China would make use of the flexibility to let the yuan drift gradually higher.
"It's just a gesture. The question now is whether there will be continuing speculation that China may revalue even more," said Ben Kwon, an analyst from KGI Asia in Hong Kong.
A senior Treasury official said the revaluation would have little immediate impact on the U.S. balance of trade with China, a highly charged issue in the United States.
"It is unlikely to have a significant initial impact on the trade deficit," the senior official told reporters, speaking on condition of anonymity. Demand for U.S. Treasury bonds is also likely be largely unchanged, the official said, citing the size and liquidity of U.S. debt markets.
China had long insisted that it would adopt a more flexible exchange rate system, but not until it was ready.
In March Premier Wen Jiabao (search) impishly said the timing of a move would be a surprise and has since reacted testily to increasingly vocal calls for a shift, saying the question went to the heart of China's sovereignty.
Foreign pressure has been especially intense in the United States, where many law-makers blamed their country's $162 billion 2004 trade deficit with China on an unfairly cheap yuan.
Senators were preparing a bill that would have slapped a 27.5 percent tax on Chinese imports if Beijing did not revalue but last month delayed a vote on the measure after Snow and Federal Reserve Chairman Alan Greenspan (search) said it would be counterproductive.
Greenspan said a yuan revaluation would have minimal impact on the U.S. trade deficit but urged China to adopt a more flexible currency for its own sake.
Economists said the money from China's fast-growing trade surplus, on top of a flood of speculative money into China betting on a revaluation, was making it harder for China to manage its monetary policy.
To keep the yuan's exchange rate fixed, China was obliged to buy up huge quantities of dollars. Its foreign exchange reserves swelled to $711 billion at the end of June, the world's largest stockpile after Japan's. Much of the money has been invested in U.S. bonds, helping to keep U.S. interest rates low.
Get all the stories you need-to-know from the most powerful name in news delivered first thing every morning to your inbox