What’s are the rea­sons for China’s cur­rency de­val­u­a­tion?

S&P in praise of Chi­nese yuan de­val­u­a­tion


The slide con­tin­ues. China’s cur­rency fell fur­ther Wed­nes­day, keep­ing global in­vestors on edge. The yuan slid 1.6 per­cent on top of a 1.9 per­cent drop en­gi­neered Tues­day by the main­land Chi­nese gov­ern­ment. The cur­rency’s nose­dive is giv­ing in­vestors plenty to worry about:

The risk the Chi­nese econ­omy, the world’s sec­ond-big­gest, is weak­en­ing even faster than ex­pected.

The threat that a cheaper yuan poses to ex­ports and eco­nomic growth in other coun­tries.

The pos­si­bil­ity that China’s move will trig­ger a beg­gar-thy-neigh­bor cur­rency war.

And the prospect that it will force the U.S. Fed­eral Re­serve to re­think a widely ex­pected U.S. in­ter­est rate hike this year — a pos­si­bil­ity that cre­ates un­cer­tain­ties for fi­nan­cial mar­kets.

How Did This Start?

In a sur­prise move, China de­val­ued the yuan on Tues­day. Bei­jing doesn’t let buy­ing and selling in fi­nan­cial mar­kets set its ex­change rate the way the United States and other de­vel­oped coun­tries do. In­stead, it links the yuan’s value to a bas­ket of cur­ren­cies. The com­po­si­tion of the bas­ket is a se­cret, but it’s be­lieved to be dom­i­nated by the U.S. dol­lar.

Each day, the Peo­ple’s Bank of China sets a tar­get for the yuan, then lets the cur­rency trade 2 per­cent above or be­low that level. On Tues­day, the cen­tral bank set the tar­get 1.9 per­cent be­low Mon­day’s — the big­gest one-day change in a decade.

What’s China’s Mo­ti­va­tion?

Main­land China says the de­val­u­a­tion was part of an ef­fort to give mar­ket forces a big­ger say in the ex­change rate — some­thing the United States and the In­ter­na­tional Mon­e­tary Fund have long called for. Chi­nese peo­ple, wor­ried about the econ­omy and seek­ing in­vest­ment op­por­tu­ni­ties abroad, have been pulling money out of the coun­try. That ex­o­dus has held down the yuan’s value. But be­cause the yuan was tied to a ris­ing U.S. dol­lar, it re­mained at high lev­els. By de­valu­ing the yuan, the Chi­nese gov­ern­ment was catch­ing up to the mar­ket, not try­ing to coun­ter­act it.

Or so Bei­jing says. Many econ­o­mists also sus­pect a con­tribut­ing fac­tor: Bei­jing may be des­per­ately try­ing to boost its econ­omy. A cheaper yuan gives Chi­nese ex­porters a price ad­van­tage in for­eign mar­kets. And they need help: Ex­ports dropped a steep 8.3 per­cent in July year over year.

Why Are In­vestors So Freaked Out?

Plenty of rea­sons. The sur­prise de­val­u­a­tion sug­gests that some­thing is spook­ing the main­land Chi­nese gov­ern­ment. Per­haps the Chi­nese econ­omy is de­cel­er­at­ing even faster than any­one re­al­izes. Al­ready, the IMF is fore­cast­ing 6.8 per­cent eco­nomic growth in China this year, the slow­est rate since 1990. Signs of trou­ble are ac­cu­mu­lat­ing. On Wed­nes­day, for in­stance, China re­ported that auto sales sank 6.6 per­cent in July.

In­vestors are also wor­ried about how a weaker yuan will af­fect ex­porters in other coun­tries. Shares in ex­porters such as Cater­pil­lar and Gen­eral Elec­tric fell in the mar­ket rout this week, though many econ­o­mists say the yuan’s drop so far isn’t sig­nif­i­cant enough to do much dam­age.

Then there’s the chance that other coun­tries will adopt copy­cat de­val­u­a­tions to help their ex­porters

Credit rat­ing agency Stan­dard & Poor’s praised main­land China’s de­val­u­a­tion of its cur­rency on Wed­nes­day and said the move did not threaten a cur­rency war.

“China’s sur­prise move to al­low for more ex­change rate flex­i­bil­ity makes good eco­nomic sense and is not the start of a cur­rency war or an at­tempt to jump-start com­pete with China, thereby ig­nit­ing a cur­rency war that disrupts in­ter­na­tional trade. On Wed­nes­day, Viet­nam al­lowed its cur­rency to weaken in re­sponse to China’s move.

Fi­nally, the Chi­nese de­val­u­a­tion com­pli­cates the Fed’s de­ci­sion-mak­ing. The U.S. cen­tral bank, in­creas­ingly con­fi­dent in the strength of the U.S. econ­omy, is ex­pected to raise the short-term rate it con­trols later this year. The Fed has kept the rate at zero since De­cem­ber 2008. But a cheaper yuan poses a threat to U.S. ex­ports and eco­nomic growth. It also low­ers in­fla­tion, al­ready run­ning be­low the Fed’s 2 per­cent an­nual tar­get. Still, most econ­o­mists sus­pect the yuan’s drop won’t have much of a last­ing im­pact. They con­tinue to ex­pect the Fed to raise rates at its Septem­ber meet­ing. growth,” S&P said.

Bei­jing on Tues­day sur­prised global fi­nan­cial mar­kets by de­valu­ing its cur­rency the yuan by nearly two per­cent against the U.S. dol­lar.

A sec­ond cut on Wed­nes­day brought re­duc­tions this week in the yuan to 3.5 per­cent against the U.S. dol­lar to its low­est level in four years.

The move to al­low more flex­i­ble trad­ing “could help main­tain the flex­i­bilty of the coun­try’s mon­e­tary pol­icy as cross-bor­der fi­nan­cial flows in­crease,” S&P said.

The shift is part of an ef­fort to com­ply with con­di­tions set by the In­ter­na­tional Mon­e­tary Fund (IMF) to qual­ify the main­land Chi­nese cur­rency in the IMF’s “spe­cial draw­ing rights” bas­ket.


A man stands in front of a for­eign cur­rency ex­change booth in Hong Kong on Thurs­day, Aug. 13. Main­land China cut the ref­er­ence rate for its cur­rency for the third straight day on Thurs­day, author­i­ties said, af­ter their sur­prise de­val­u­a­tion of the yuan this week un­set­tled global fi­nan­cial mar­kets.

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