Fight inflation now but no currency appreciation, says China's Wen

03/15/2010 9:37 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

So much for that then.

In remarks that put a period to the annual meeting of China’s National People’s Congress Premier Wen Jiabao said that China’s currency is not undervalued. “We oppose all countries engaging in mutual finger pointing or taking strong measures to force other countries to appreciate their currencies.”

I think that puts an end to any hopes that China would start to let the renminbi appreciate against the U.S. dollar in the window before the state visit of China’s leaders to the United States in April. The currency futures market apparently agrees. On Monday March 15 the non-deliverable 12-month futures contract dropped 0.3% to 6.6435 renminbi to the dollar. That’s the biggest drop in more than a month. The Chinese currency is now pegged to the U.S. dollar at 6.83 renminbi to the dollar.

Keeping the renminbi pegged to the dollar makes it tougher for China’s government to fight inflation and to curb speculative excess in China’s real estate and stock markets. An undervalued renminbi—or even just the perception of an undervalued renminbi—brings more hot money into the country, pushing up prices for stocks and real estate. And this at a time when inflation seems to on the market—the annual inflation rate rose to 2.7% in February from 1.5% in January.

At the same time as Wen was ruling out any appreciation in China’s currency, he also stepped up the fight against inflation. And that rattled markets.

He announced a new inflation target of just 3% for 2010. That target is significantly lower than last year’s target of 4% inflation. The premier also raised the rhetorical stakes saying “If there is inflation plus unfair income distribution and corruption, it will be strong enough to affect the stability of state power.”

All this talk of fighting inflation and of tougher inflation-fighting goals—while currency appreciation is at the same time off the table—has convinced financial markets that Beijing has accelerated plans to increase ban k reserve requirements again—perhaps as early as this week--and to raise interest rates—perhaps in April.

The worry, of course, is all this would slow China’s economy. On Monday, March 15, the Shanghai Composite stock index fell 1.5%. Commodity prices also declines with copper, for example, down 0.8%.

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