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Currency Report Signals Improvements in China, Uneven Results in Korea

Thursday, October 22, 2015
Sandler, Travis & Rosenberg Trade Report

In its semiannual report on foreign exchange rate policies released Oct. 19, the Treasury Department appeared cautiously optimistic about the valuation of the Chinese yuan against the dollar but critical of continued exchange rate intervention by Korea. The report again determined that none of the United States’ major trading partners is manipulating its exchange rate to gain an unfair trade advantage.

Treasury states that after China surprised markets Aug. 11 by announcing a change in how it sets the daily reference rate of its exchange rate regime, the yuan depreciated 2.3 percent against the dollar through September. There were expectations of further depreciation in the short run, but it appears that China sold a significant amount of reserves in August to stem the decline. While the yuan’s near-term trajectory is difficult to assess, the report suggests that it may resume its appreciation against the dollar given that it has appreciated nearly 30 percent in real effective terms since 2010 (and had appreciated during 2015 prior to the shift) and that the core factors that have driven appreciation remain in place.

For now, Treasury concludes that the yuan remains below its appropriate medium-term valuation. This seems to be an upgrade from the language of the previous report, which found the yuan to be “significantly undervalued.” Treasury states that it will carefully monitor the implementation of the new exchange rate policy approach and how it will work in practice, particularly whether China will allow the yuan to respond to market forces for appreciation as well as for depreciation.

The report also finds that a number of factors continue to point to an undervalued Korean won. In the year through September, the won depreciated by 7.7 percent against the dollar and 2.0 percent on a real trade-weighted basis. Treasury estimates indicate that Korea continued to intervene to resist pressure for the won to appreciate against the dollar in the first half of 2015 but then sold foreign exchange in July and August to limit won depreciation, so that intervention over the calendar year to date appears roughly balanced. The report notes that the appreciation of the won over the medium term would help Korea reorient its economy away from its current heavy reliance on exports by encouraging the reallocation of resources to the non-tradables sector.

The report’s findings could bolster efforts to add stronger protections against currency manipulation to the recently-concluded Trans-Pacific Partnership by means of a side agreement that is reportedly still being negotiated. Neither China nor Korea is among the existing 12 TPP members, but Japan, which has been criticized for its currency interventions in the past, is, and there is speculation that Korea and perhaps eventually China could join the agreement.

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