China devalues yuan by 2%, biggest one-day fall since 1994

Tuesday, Aug 11, 2015,22:45 IST By metrovaartha A A A

Beijing | In a surprise move, China today devalued its tightly-controlled currency by two per cent, the biggest one-day fall since a massive devaluation in 1994, as the world’s second-largest economy grappled with economic slowdown and dwindling exports. A cheaper yuan will make Chinese exports cheaper by boosting overseas sales, one of the key drivers of growth during the communist giant’s remarkable growth story over the past three decades, but which have recently shown signs of weakening.
Effective from today, the daily central parity quotes reported to the China Foreign Exchange Trade System before the market opens should be based on the closing rate of the inter-bank foreign exchange rate market on the previous day, supply and demand in the market, and price movement of major currencies, the People’s Bank of China (PBOC) said.
Following the change, the central parity rate of the RMB or the yuan weakened sharply by 1,136 basis points, to 6.2298 against the US dollar compared to 6.1162 yesterday, down nearly 2 per cent, state-run Xinhua news agency reported. The PBOC’s move marked the biggest drop since China reformed its currency system in 2005 by unpegging the yuan from the US dollar.
The nearly 2 per cent plunge was the biggest one-day fall since a massive devaluation in 1994 when China aligned its official and market rates. The PBOC defended the move citing a strong US dollar and sharp appreciation in the RMB real effective exchange rate as key considerations behind the policy change.
The PBOC said the RMB’s central parity has deviated from its actual market rate by a large extent and for a long duration, which has undermined the authority and the benchmark status of the central parity system. Chinese authorities said the change would help drive the currency toward more market-driven movements.
The move also signalled the government’s growing worry about slow economic growth. A shift toward a weaker currency could help flagging exports, analysts said. The PBOC said the RMB’s central parity has deviated from its actual market rate by a large extent and for a long duration, which has undermined the authority and the benchmark status of the central parity system.
As the economy of the United States improves, with interest rate hikes highly expected within this year, currencies of emerging economies have generally depreciated against their currency and a strong RMB has created pressure on China’s exports, the PBOC said in a separate statement.
The new measure announced by PBOC is the clearest sign yet the government may let the currency soften after worsening economic data and a stuttering stock market, Hong Kong based South China Morning Post reported.
The international economic and financial conditions are very complex. The US dollar is strengthening, while the Euro and Japanese Yen are weakening. Emerging market and commodities currencies are facing downward pressure, and we are seeing increasing volatilities in international capital flow, The Post quoted a spokesman of the PBOC. So far the Chinese government had resisted calls from economists to let the currency devalued to boost the economy, which hovered around seven per cent with forecast that it would go down to 6.8 per cent. Coupled with that the recent stock market crash which wiped outabout USD 3.2 trillion of capital, export declined by 8.3 per cent year on year in July.
I am not surprised at all. The Chinese government will let the renminbi weaken gradually. It will keep doing this policy easing, including cutting interest rates to help the economy, William Mo, Tung Shing Securities vice president told the Post.
With the US Federal Reserve poised to hike interest rates possibly as soon as next month, the US dollar will only get stronger increasing the pressure on China to give the yuan more freedom to trade lower, he said. The PBOC spokesman also said there would be further market-orientation and that the central bank was now soliciting quotations from market makers before setting the mid price – a first for the PBOC, the Post report said. Today’s sharply lower rate has been described by the PBOC as a one-off adjustment, which has bridged the previously accumulated differences between the central parity rate and the market rate.
Analysts believe the central bank’s policy will allow market forces more sway in exchange rate determination and help China to send the RMB into the benchmark currency basket of the International Monetary Fund (IMF), the Xinhua report said. Today’s move is likely intended to improve the ‘market-driven’ quality of the PBOC daily fix, so that it can qualify to be used by the IMF as a Special Drawing Rights (SDR) reference rate, said Wang Tao, chief China Economist at UBS.
Wang expects the USD-CNY exchange rate to be around 6.5 by the end of 2015, up from his previous forecast of 6.3. Analysts quoted by Xinhua, however, dismissed perception that the devaluation was aimed at helping exports. Exports have indeed been soft this year, but this is largely a reflection of sluggish external demand, the HSBC said in a research note. In an environment of a soft global recovery, the benefits of beggar-thy-neighbor competitive devaluation are neither clear nor easy to reap, it said.
The HSBC forecast an additional 25 basis points (bps) interest rate cut and 200 bps reserve ratio cut in the second half of this year. The combination of monetary and fiscal policy support should help ensure that the economy on a path of cyclical recovery and achieve the growth target of around 7 per cent, it said.