Pressure on Yuan Mounts; Is Great Fall of China Next?

TOKYO —  The mother of all currency devaluations--by China--is being treated as increasingly likely across Asia as the Chinese economy deteriorates, Japan withers and speculators ramp up pressure on the Hong Kong dollar.

Such a step would probably trigger a string of competitive devaluations across Asia, with devastating consequences for the region and the U.S. and global economies.

“If the Hong Kong dollar and the Chinese yuan are devalued, other Asian currencies would have to devalue again,” said Koji Ono, chief financial analyst with Kankaku Research Institute. “If another round happens, the impact on the U.S. economy will be a lot more serious.”

Reflecting the pressure, Hong Kong stocks plunged 3.25%, or 235.95 points, Friday to close at 7,018.41, their lowest level since January 1995. Adding to the jitters, Vietnam devalued its currency by 10%.

Newly named Japanese Prime Minister Keizo Obuchi did little to lift the fog hanging over the world’s second-largest economy in a policy speech bereft of new initiatives needed to fix the nation’s beleaguered banks, sagging currency or limp economy. Despite his pledges to take “decisive, swift steps” to fix the problem, the markets saw more empty pledges.

Disappointment over Obuchi’s remarks and general anxiety throughout Asia drove the dollar up 1.81 yen to 146.13 in New York.

Currency traders say hedge funds--the “financial bad boys” that some blamed for starting the Asian crisis--raised their bets sharply against the Hong Kong dollar this week. Should they succeed in breaking the link between the territory’s currency and the U.S. dollar, known as the peg, they stand to make a fortune.

“The hedge funds are putting a lot of pressure on Hong Kong,” said a Singapore-based dealer at one large financial institution who asked not to be identified.

“In the long term, the peg will have to go. But if the authorities allow it to go now, it will be very bad. All the good work done by [South] Korea, Indonesia, Thailand and the [International Monetary Fund] to restructure goes to waste.”

Speculators have tried before and failed to break the 15-year-old peg, most notably in late 1997 and early 1998 when other Asian currencies were falling like dominoes. Each time Hong Kong authorities, backed by $96 billion in foreign currency reserves, defended their currency and fought them off.

“They’re reluctant to let it go without a fight,” said Jonathan Hazell, Singapore-based Asian strategist with Barclays Capital

What’s brought on this most recent assault is perceived weakness in China’s economy, the vulnerability inherent in Hong Kong’s monetary balancing act, and real or imagined links between the yuan and the Hong Kong dollar.

China is under pressure for several reasons. Its economy must grow by at least 8% annually, economists believe, to avoid massive unemployment, social unrest and bank failures while it restructures its bloated, money-draining state-run companies.

Yet growth has slipped in recent months, and some analysts now fear actual growth could be edging close to 6%. Industrial production is at two-thirds of last year’s levels, and retail sales have been halved.

“The numbers are looking very ugly,” said Connie Leung, senior Asian economist with Lehman Bros.

Meanwhile, China’s exports are being squeezed as the Japanese consumer appetite nose-dives and devalued Asian currencies undermine the competitiveness of China’s steel, petrochemical and textile makers.

Exports are a strategic linchpin for the Asian giant, accounting for about 25% of the gross domestic product’s growth and representing one of the few new job sources for city dwellers most likely to take to the streets.

Further adding to market jitters is the fact that black market rates for China’s controlled currency this week slid below China’s own peg of about 8 yuan to the U.S. dollar, prompting market players to smell blood.

All of this has led to renewed concerns that China could feel backed into a corner and conclude it has no choice but to devalue its currency to regain its competitive position. That, in turn, would prompt tit-for-tat moves by Asian competitors, further undermining the region’s tenuous position.

China used the implicit threat of a devaluation in June--just before President Clinton’s high-profile trip to Beijing--to arm-twist the Federal Reserve Board into intervening in currency markets and shoring up the yen. But many think this may be a bit of lion dancing, because devaluation isn’t necessarily in China’s best interest anyway, given the risk of unleashing the currency equivalent of mutually assured destruction.

“At the end of the day, devaluations have not helped anyone,” said Deep Kapur, Singapore-based regional strategist with Salomon Smith Barney. “There’s no end to the game.”

In fact, China has probably benefited by not devaluing--thereby appearing to act in Asia’s and the world’s interest--and looking good at Japan’s expense as Tokyo becomes ever more mired in policy confusion.

And China has other options to refuel its economy, such as tax rebates and subsidies for exporters, a streamlining of permits and other bureaucratic headaches, and expanded public spending. Flood cleanup will put more money into the economy as will announced spending on roads and rail lines.

Hong Kong, meanwhile, faces a very different set of variables. The territory’s monetary authorities have successfully countered speculators by buying enough Hong Kong dollars to keep the currency around the 7.75 level to the U.S. dollar. But that came at a steep price. Interest rates rose and the value of assets such as stocks and real estate plummeted.

Integral to this week’s renewed pressure on the Chinese and Hong Kong currencies is the perceived link between the two. Although the Asian giant and its rich little jewel have distinct monetary policies, currencies and reserves, China’s takeover of Hong Kong on July 1, 1997, has linked the two inextricably in many people’s minds. China has a political and economic interest in shoring up Hong Kong’s currency, but this link also suggests that if one peg is broken, the other would quickly follow.

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Etsuko Kawase in The Times’ Tokyo bureau contributed to this report.