Outlook 2008 (The watch list): Yuan

The pressure is on China to raise the value of its currency.

A cheap yuan hurts Canadian exports to America. At least that’s the message Ottawa is touting these days, citing the United States’ massive trade deficit with China (which was US$23.8 billion in September alone) as a cause for the greenback’s depreciation against the loonie. The solution? Let the yuan appreciate more quickly against the U.S. dollar and other major currencies, urge Canadian finance officials, whose views are shared by their counterparts south of the border, Europe and Japan.

In response to such international pressure, China’s Premier Wen Jiabao recently announced the market will play a larger role in valuing the yuan, but the process would be “gradual.” That doesn’t surprise Richard Kelly, senior economist at Toronto-Dominion Bank, who expects the yuan to appreciate only 5% against the greenback and 3% versus the loonie in 2008. “China has been hesitant on the exchange rate side, since they see that as their bread-and-butter way of keeping their economy moving forward,” Kelly says.

Nevertheless, Beijing could end up boosting the yuan’s value more quickly, if other measures can’t keep a lid on China’s inflation, which is running at 6.5% per year. One thing is certain: the Asian economic powerhouse will make changes to its currency on its own terms.