China followed through Monday on its pledge to allow greater flexibility in exchange rates, but said an appreciation in its currency alone could not rebalance world growth as it urged world leaders to carry out more fundamental reforms.
By late Monday, the yuan was trading at 6.7971 to the U.S. dollar in the spot market, strengthening from 6.8272 on Friday — as the central bank delivered on its weekend promise to give up the dollar peg imposed two years ago to help Chinese exporters cope with the global downturn.
For the past two years, Beijing has kept the yuan trading in a much narrower band around 6.83 to $1.
But analysts said the move was mainly aimed at countering criticism of Beijing's currency policies ahead of this weekend's summit of the Group of 20 leading economies and would not result in any significant shifts in exchange rates. The yuan is still subject to a 0.5 percent daily trading range, limiting potential volatility.
"The yuan will gain very soon, but definitely not much. It was more of a strategic maneuver to silence outside criticism," said Qian Qimin, a market analyst at Shenyin Wanguo Securities, in Shanghai.
The central bank said plans to allow greater currency flexibility were in line with China's own needs and would help Beijing fight inflation, encourage manufacturers to improve efficiency and reduce the country's reliance on exports as a key driver for growth.
U.S. Ambassador to China Jon Huntsman called the move a "genuine attempt" by China to have greater flexibility in its exchange rate mechanism. He said a stronger yuan would boost the purchasing power of Chinese buyers and help U.S. exports.
U.S. lawmakers have strongly criticized China's exchange rate policy, saying an undervalued yuan has cost millions of American jobs. Washington and other trading partners complain that an undervalued yuan gives China's exporters an unfair advantage.
"When you stop to consider that every billion dollars in exports creates 22,500 jobs, that's a very big deal at a time when we're facing very high rates of unemployment," Huntsman told the Hong Kong General Chamber of Commerce. "It takes an irritant off the table in the U.S.-China relationship."
China's economy surged 11.9 percent in the first quarter of this year and exports jumped by nearly 50 percent over a year earlier in May, despite expectations that Europe's debt crisis would hit demand in the 27-nation European Union, China's biggest trading partner.
"The large trade surplus gives the government confidence and room to loosen controls over the exchange rate," Qian said, since a stronger yuan would make Chinese exports more expensive.
The announcement by the People's Bank of China that it would revert to relying on a basket of currencies that includes the U.S. dollar to determine the exchange rate, rather than the dollar alone, reflects a return to policies in force before the global financial crisis walloped Chinese manufacturers in 2008, putting millions of workers out of their jobs.
But while it has pledged to keep moving gradually toward more market-based exchange rates, Beijing still insists that its policy of keeping the currency stable is crucial for economic recovery, ruling out any significant one-off revaluations.
"The official announcement should be interpreted first and foremost as an important signal towards a more flexible exchange rate, rather than a significant revaluation of the Chinese yuan," UBS economist Wang Tao said in a report on the change.
China let the yuan to rise by about 20 percent beginning in 2005, but halted its rise in 2008. The government sets the rate each day before the start of trading and retains powerful tools to control its movement.
Many countries have slammed Beijing for this policy, complaining that an undervalued yuan unfairly drives down the price of Chinese products and makes them impossible to compete with.
China has sought to deflect this criticism, noting that the causes of the global crisis lay well beyond its door, and a commentary Monday by the official Xinhua News Agency said the G-20 leaders must focus on more urgent global reforms.
"If they cannot make good use of the coming G-20 summit to press ahead with the much-needed overhaul of the global financial system, the international community will soon find to its disappointment that its leaders look only for red herrings, rather than real solutions, at a time when true leadership is badly needed," it said.
Regional markets gained Monday, as investors relieved of uncertainty over China's currency policy bought airlines and other heavyweight shares.
"The markets were boosted because investors are becoming less risk averse than before. They are more aggressive," said Ben Kwong Man Bun, chief strategist for KGI Securities in Hong Kong.
While foreign manufacturers have welcomed the relief a stronger yuan would bring, exporters in China, already operating on razor-thin margins, were less pleased.
"The exchange rate problem is one we would have to face sooner or later. That is a fact we have to accept," said Bai Ming, deputy general manager of Zhejiang Mingfeng Car Accessories Co., which exports car covers to the Americas, Europe and South Korea.
Bai, whose factory employs 950 people, said his company's export orders were outpacing his capacity to meet them. But with labor and other costs rising, the company will have to find a ways to stay competitive.
"What we are trying to do is to raise productivity and save costs. We cannot just sit back and wait," he said.
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