China has released details of the currency basket that determines the value of the yuan after its July revaluation. It is weighted mostly to the U.S. dollar, euro, Japanese yen and Korean won, the currencies of China's biggest trading partners. But the governor of China's central bank said the currencies of Singapore, U.K., Malaysia, Russia, Australia, Canada and Thailand are also important in setting the yuan's foreign exchange rate.

By tying the value of the yuan to a basket of currencies, China is building in flexibility, analysts agree. This may be especially prescient during times of financial crisis. For example, Singapore widened the band over which its dollar could move during the Asian financial crisis. If the market was pushing the currency beyond the band, Singapore's central bankers could intervene to buy or sell to keep the dollar in an acceptable range. China's revaluation strategy relies on its central bankers actively monitoring and trading the yuan. It appears they feel ready to take on some of the risks of world financial markets.

On the same day it released details of the currency basket, China announced it will allow companies that import or export more than US$2 billion to trade directly with banks in China's foreign exchange market. Domestic and foreign banks also can apply for approval to conduct forex forward trading. China has begun to approve mainland brokerages expanding overseas, with CITIC Securities receiving the OK to set up in Hong Kong. So financial liberalization has accompanied this revision of the yuan policy.

'Approved destinations' to benefit from more foreign exchange leaving China
Chinese tourists have been approved to spend more overseas with up to US$5,000 of foreign exchange allowed out of the country. That's an increase from US$3,000 previously. Annual foreign exchange for overseas students is now US$20,000. With the appreciation of the yuan, more Chinese are expected to be able to afford overseas travel. This will help popular destinations like Hong Kong and all the "approved destination" countries.

With its high savings rate, China now sees it can afford to let more foreign exchange out of the country. U.S. observers are worried that China will buy fewer U.S. Treasuries and less fixed income assets in the U.S., especially if more revaluations are to come. China is the second largest foreign holder of U.S. Treasuries with more than US$243 billion and treasuries initially dropped when the peg to the U.S. dollar was removed. In the longer term, China wants those reserves in place to help it manage future currency risk, so Chinese money may continue to flow into U.S. instruments. This will have the effect of keeping U.S. economy stable in the face of rising debt. China's foreign reserves were second largest in the world at US$711 billion in July.

The revaluation is expected to ease the debt burden on Chinese companies that have borrowed heavily in foreign currencies, such as the airline sector. Chinese firms that buy most of their raw materials abroad, especially the steel sector, will be further ahead as their money will buy more commodities. But there is risk in the longer term, as the cost of their exports will rise. For the oil and gas sector, it's a mixed bag, hurting upstream business but helping downstream. If the Chinese economy slows, it will reduce demand for oil, but slow in China is still rapid by most of the world's expectations, and consumption will continue to rise, putting pressure on world oil prices.

Exporters will feel the effect of the new revaluation
Big exporters of consumer goods, including toys, shoes, textiles and electronics products, are expected to be most affected. Margins are low in these businesses and labour costs significant. Even a small revaluation can make their product less competitive and less attractive in Western markets. Electronics manufacturers are most likely to suffer a profit decline. Chinese OEMs will have more capital to buy components overseas, but will be watching their manufacturing costs at home to make sure they don't become uncompetitive. If it becomes too costly to assemble goods in China, firms in the electronics sector may start looking at other countries.

The flip side of a revalued yuan is that Western consumers will almost certainly see higher prices for some consumer goods. That could hurt Western retailers and could contribute to inflation.

Multinational firms that signed contracts with Chinese partners may be reevaluating their currency risk, as their end of the deal now costs more. U.S. firms that are heavily committed to investment in China will suffer. But most multinationals now operating in China are in for the long term. China's role is changing from "a production base to a business location," says Toshiba Corp. Chairman Tadashi Okamura, speaking to Nikkei Weekly. Firms like Toshiba see the great potential of its huge consumer market, as well as the lower costs of manufacturing. For this reason, the auto sector is not expected to be affected, though there may be pressure for wages to rise. Japanese and U.S. makers still see China as the low-cost manufacturing base and say they will increase the local content of their vehicles.

For most multinationals, there is no choice but to operate in a market that has such firm prospects for growth. "China isn't an option. It's essential. It's our No. 1 priority," John Beystehner, chief operating officer at UPS, said recently, according to Associated Press. UPS plans to build a shipping hub in Shanghai. Even Indian firms, which would appear to have plenty of cost advantages close to home, say they see opportunities in moving production into China. Firms such as appliance maker Bajaj Electricals and transformer board maker Raman Boards have already invested in Chinese factories. As production costs go up in China's major cities, such as Shanghai and Beijing, multinationals are looking at second-tier cities. Minimum wage is slightly lower in the less developed centres and property and other costs may also be less. This will help spread the wealth into other parts of China and create more consumers able to buy foreign products.

China still faces protectionism and quota limits
The recent revaluation hasn't solved China's problems with protectionism. The EU is threatening to block imports of Chinese knitwear, saying the annual quota has been met. The Chinese retort that they have to sell about 800 million shirts to buy an Airbus. U.S. congressional representatives are still calling for high tariffs to stop the import of Chinese goods and are scandalized when Chinese firms try to take over American businesses. CNOOC has abandoned its plan to take over Unocal and Haier is no longer bidding for Maytag.

But as the yuan rises, Chinese firms making bids for overseas holdings are in a better position. There are likely to be more such bids in the next few years. Firms such as Haier, Shanghai Auto, TCL and Lenova face stiff competition at home. Buying overseas assets helps them compete. In some cases, such as MG Rover, Chinese firms are bidding against one another for a share of the expertise and equipment that can come from the West. Nanjing Auto ultimately outbid Shanghai Automotive Industry Corp. to take over the British automaker, but SAIC retains the rights to two Rover designs.

Chinese capital will help Western securities markets
Westerners are going to have to get used to the increased presence of Chinese firms, says Jeremy Siegel of Wharton Business School. Siegel, author of The Future for Investors, believes that Chinese capital will fill the void when the baby boomers of North America and Europe are no longer in their savings years. As the baby boom moves into retirement, there is a great risk that capital for securities markets will dry up because retirees are drawing down capital. China, with its high savings rate, and India, with its ambitious companies, will move in to provide capital and opportunity for expansion for Western business, Siegel says. If Western economies don't allow the Chinese in, then stock and bond markets could be in for precipitous falls.

One of the ways China will allow its capital out of the country is through allowing some of those savings to flow into international investment. The Qualified Foreign Institutional Investor program (QFII), allowing foreign money into China, is being widened and a Qualified Domestic Institutional Investor program or QDII is planned. Last year insurance companies began to invest some funds abroad in bonds and other secure instruments. Now there is a proposal to allow institutional investors such as the insurers to invest in overseas stock.

Technology and retail sector heats up with internet competition and big-box stores
China's nurturing of the technology sector is beginning to pay off, with the success of firms such as Baidu.com, which had a very successful IPO in the U.S. The stock, offered at US$27, hit a session high of US$151, almost four times its subscription price. This was a much bigger gain than even Google experienced during its listing. Google owns 2.6% of Baidu. Baidu is creator of an internet search engine that works effectively with Chinese characters. It leads the Chinese search market with 37%, followed by Google's 23% and Yahoo's 21%.

Multinational competitors are scrambling to get similar leverage among Chinese internet users. Google plans to open a product research and development centre in China. Yahoo of the U.S. has bought 40% of B2B website provider Alibaba Corp. for US$1 billion. Alibaba also operates Taobao, a free website for individuals who want to buy and sell goods. Taobao has a stronger hold on the market than EBay, which is a relative newcomer in China. EBay has pledged to pour US$100 million into the market, saying it is vital for future growth. Bokee.com, China's most visited blogsite, has raised US$10 million in financing from three U.S. venture capitalists, Softbank Investment International of Hong Kong and a Chinese investor. China's internet-savvy population was 103 million people in July, but the market is in its infancy. There is tremendous potential for growth. 

The internet generation that these companies are working with is mainly under age 25. China's young people have boundless optimism and are more willing to part with their money than the older generation. Many are confident they will be able to afford flats and cars and household luxuries and have plans to spend money on these items in the next three years. Retailers such as Wal-Mart, which has had difficulty growing in mature markets like Britain and Europe, sees a lot more potential in reaching Chinese consumers. China has few restrictions on big-box stores. Wal-Mart has signed deals with a property consortium to anchor a dozen malls in various parts of China. Retail sales in China are strengthening and there is unlimited upside as economic good fortune reaches Chinese in the second-tier cities and rural areas that were previously undeveloped. No matter what level the yuan reaches against the U.S. dollar, China is the market of the future.