By Bloomberg News June 21 (Bloomberg) -- The yuan climbed the most in 20 months against the dollar and forwards jumped after China’s central bank relaxed a two-year peg before a Group of 20 summit this week. The currency advanced 0.36 percent to 6.802 per dollar as of 1:45 p.m. in Hong Kong, the biggest gain since Oct. 7, 2008, according to the China Foreign Exchange Trading System. The 12- month non-deliverable yuan forward rose 1.4 percent to 6.6209, implying traders are betting on a 2.7 percent appreciation. A stronger yuan will help curb inflation in the world’s third-largest economy and shift investment toward service industries from export-manufacturing, the People’s Bank of China said yesterday. The move may also deflect criticism from President Barack Obama and other G-20 leaders, who say China relies on an undervalued currency to promote overseas sales. “Investors are buying and testing the central bank’s bottom line,” said Liu Dongliang, a Shenzhen-based analyst at China Merchants Bank Co., the country’s fifth-largest lender by market value. “But the central bank may take action when volatility is excessive.” Asian currencies gained, with South Korea’s won strengthening 2.4 percent to 1,174.15 versus the greenback and the Taiwan dollar climbing 1.2 percent to NT$31.818. The MSCI Asia Pacific Index of regional stocks jumped 2.8 percent and oil rose 2 percent on speculation a stronger yuan will boost the purchasing power of the world’s most-populous nation. Limited Gains Chinese authorities had prevented the currency from strengthening against the dollar since July 2008 to help exporters cope with the global financial crisis. The currency appreciated 21 percent in the three years after a peg to the dollar was scrapped in July 2005 and replaced by a managed float against a basket of currencies including the euro. Gains this time around may be more moderate because the yuan has already strengthened 16 percent against the euro this year, eroding earnings for Chinese exporters in the European Union, the nation’s largest market. The yuan may climb 1.5 percent against the dollar to 6.7 by Dec. 31, according to the median estimate of 14 analysts surveyed yesterday by Bloomberg. ‘Partial Victory’ “The yuan’s appreciation against the dollar may be limited over the next six months after the Chinese currency gained significantly against the euro,” said Ma Jun, a Hong Kong-based economist at Deutsche Bank AG. U.S. politicians can only “declare this a partial victory,” he said. China’s central bank today set its daily yuan reference rate unchanged at 6.8275, according to China Foreign Exchange Trade System. The currency is allowed to fluctuate up to 0.5 percent from the official rate. The People’s Bank of China said on June 19 it will allow greater currency “flexibility.” Yesterday, it ruled out “large changes” in the exchange rate and said it will prevent “excessive” moves. The central bank, which has accumulated $2.4 trillion in reserves by intervening in currency markets, said it will maintain the trading band and curb inflows of short-term speculative capital. Intervention Risk Authorities will “ensure the exchange rate’s fluctuation is controllable and prevent the possibility of market forces causing excessive adjustment in the rate,” the central bank said in a statement on the policy change yesterday. It said that 16.3 percent of China’s trade is with the EU, compared with 12.9 percent for the U.S., making it important to manage the yuan with reference to the basket of currencies. “We can’t exclude the possibility of yuan depreciation,” said Shen Jianguang, Mizuho Securities Asia Ltd.’s chief economist for Greater China, who said a 2.5 percent drop is possible this year if the dollar-euro rate is unchanged. Even so, he added, China needs to show flexibility in its currency before the G-20 summit in Toronto on June 26-27. U.S. Senator Charles Schumer said lawmakers will push ahead with proposals for trade sanctions until they are convinced the advance is fast enough to allow fair competition. Textiles makers stand to lose the most from appreciation and some would “face bankruptcy” with profit margins as low as 3 percent, Zhang Wei, vice chairman of the China Council for the Promotion of International Trade, said in March. Europe’s debt crisis has added to pressure on their earnings. Swift Umbrella Co., based in the southern Chinese province of Fujian, was forced by European buyers to cut prices 6 percent this year, Xu Youchuan, sales manager, said in a June 2 interview. Shrinking Surplus China’s balance of payments indicates no need for “large changes” in the yuan, which is “not too far from equilibrium level,” the central bank’s statement said. The current-account surplus, the widest measure of trade, narrowed 32 percent to $297 billion in 2009, government data show. Exports have been rebounding, exceeding imports by $19.5 billion in May, from a $1.68 billion surplus in April and a deficit of $7.24 billion in March. Overseas sales jumped 48.5 percent in May from a year earlier, customs bureau data show. The World Bank said last week that a stronger currency would help China cool inflation, which accelerated to a 19-month high of 3.1 percent in May, higher than the government’s full- year target of 3 percent. Companies focused on the Chinese market, including Beijing- based computer maker Lenovo Group Ltd. and Shanghai-based China Eastern Airlines Corp., said in March that they would gain from lower import costs and stronger consumer purchasing power. “This time it will be a very gradual appreciation but it could be front-loaded too,” said Nizam Idris, a Singapore-based currency strategist at UBS AG, the world’s second-largest foreign-exchange trader. --Judy Chen, Belinda Cao, Bob Chen, Frances Yoon, Yanping Li, Patricia Lui. Editors: Sandy Hendry, James Regan To contact the reporters on this story: Judy Chen in Shanghai at Xchen45@bloomberg.net.

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