SHANGHAI: China’s central bank on Tuesday devalued its yuan currency by nearly two percent against the US dollar as authorities seek to push market reforms and bolster the world’s second-largest economy.
The surprise move marked the biggest drop since China reformed its currency system in 2005 by unpegging the yuan—also known as the renminbi (RMB)—from the greenback.
It should make the country’s exports more competitive overseas, but analysts said it could prompt anger in the US.
The People’s Bank of China (PBoC) set its daily reference rate for the yuan at 6.2298 to $1, compared with 6.1162 yuan the previous day, effectively 1.86 percent lower.
The change came amid speculation China is preparing to widen the yuan’s two percent trading band for the first time since March 2014.
The range is calculated from a central “reference rate” each day. Before Tuesday, Chinese officials said they based the fixing on a poll of market-makers, but the PBoC’s move means it will now also take into account the previous day’s close and other factors.
Beijing has so far kept a tight grip on the currency’s value on fears major swings and volatile capital flows could present financial risk and reduce its control over the economy.
That has made the yuan far more stable than other major global currencies and a two percent move in its value is dramatic—before Tuesday’s announcement it had traded within a roughly 0.4 percent band for four months.
But China is also seeking to reform its yuan policy in an effort to have it included in the International Monetary Fund’s basket of “special drawing rights” (SDR) reserve currencies.
Its controls have been a stumbling block in gaining admittance to the select group, now comprised of the US dollar, Europe’s euro, British pound and Japanese yen.
The Washington-based IMF said this month that “significant work” still needed to be done for the yuan to be considered before its next review in November.
“A reasonable adjustment of the RMB’s value is good for China’s exports and also good for the RMB to be admitted to the SDR,” Liu Dongmin, director of international finance research office at the Chinese Academy of Social Sciences, told Agence France-Presse.
“But most importantly, this marks key progress for RMB exchange rate reform since 2005 and a major step for RMB marketization,” he said.
Even so the US has long argued the yuan has been kept “significantly undervalued” to help Chinese exporters, and Shanghai Finance University associate professor Qin Huanmei told Agence France-Presse Washington was likely to object to the depreciation.
“The value drop of yuan against the US dollar will put pressure on the US because it wants the yuan to appreciate, which would help with its trade,” she said.
Supply and demand
The PBoC described the sharply lower rate as a one-off move, though it did not use the term devaluation, saying the weakening in the currency reflected the new method of calculating the daily price.
The bank will now “comprehensively consider the supply and demand of foreign exchange” as well the latest international market rates for foreign currencies to set the fixing, according to a statement.
Analysts said data showing a slump in exports over the weekend could also have prompted the move, which should make Chinese goods cheaper overseas.
Exports, a key driver of the country’s growth, plunged 8.3 percent year-on-year in July, customs said Saturday, spelling more worry for the economy.
China’s gross domestic product expanded 7.4 percent in 2014—its slowest rate since 1990—and has slowed further this year. It grew 7.0 percent in both of the first two quarters, in-line with the government’s annual target for 2015.
With China’s economy already slowing, analysts said a weakening of the currency was long overdue.
“The RMB exchange rate deviated greatly from the market [consensus]before, so the one-off correction of two percent today is big,” Li Daxiao, an analyst from Yingda Securities, told Agence France-Presse.
By midday on Tuesday, the yuan was quoted at 6.3030 to the dollar, down sharply from Monday’s close of 6.2096, according to the operator of the national foreign exchange market.
But despite the potential boost to exports and economy the benchmark Shanghai Composite Index shares fell 0.40 percent by the break.