China’s Currency Slides After Beijing Announces Devaluation

Market expectations of more depreciation could cause the yuan to quickly depreciate
August 11, 2015 Updated: August 11, 2015

BEIJING—China devalued its tightly controlled currency Tuesday following a slump in trade, allowing the yuan’s biggest one-day decline in a decade.

The central bank said the yuan’s fall was due to reforms aimed at making its exchange rate system more market-oriented. Sustained weakness in the yuan raises the risk of tensions with China’s trading partners.

China’s move makes it the third major economy to take actions that weakened their currencies. Initiatives by Japan and the European Union over the past two years depressed the yen and euro. But analysts cautioned against seeing the change as a direct effort to help Chinese exporters.

The yuan had strengthened along with the dollar, hurting exporters and raising the risk of politically dangerous job losses in manufacturing industries that employ tens of millions of workers. July exports fell by an unexpectedly large margin of 8.3 percent from a year earlier, according to data released on the weekend.

Tuesday’s move “signals a new government willingness” to let the currency decline, said USB economist Tao Wang in a report.

Beijing is likely to move cautiously but market expectations of more depreciation “could quickly become entrenched” and cause the yuan to “depreciate quite quickly and significantly,” said Wang. She said that would represent a “sea change in China’s exchange rate policy” but would help to support flagging economic growth.

The devaluation could present a dilemma for the United States and other governments that accuse Beijing of suppressing the yuan’s exchange rate, giving its exporters an unfair price advantage and hurting foreign competitors.

A weaker yuan might help Chinese exporters and prompt complaints by foreign manufacturers. But the central bank said its goal was to give market forces a bigger role, a step Washington has demanded for years.

The yuan, also known as the renminbi, is allowed to fluctuate in a band 2 percent above or below a rate set by the People’s Bank of China based on the previous day’s trading.

The bank said starting Tuesday that in addition to the previous day’s exchange rate, the daily fixing of the trading band will take into account supply and demand.

“This complex situation is posing new challenges,” said a central bank statement. It said a strong yuan is “not entirely consistent with market expectation” and this was a good time to adjust controls.

The center of Tuesday’s trading band was set 1.9 percent below Monday’s level. The yuan quickly fell 1.3 percent against the dollar and was down almost 1.9 percent at midday.

That was the biggest one-day decline since Beijing ended the yuan’s direct link to the U.S. dollar in July 2005 and switched to basing the exchange rate on a basket of foreign currencies. The composition of that basket is secret but the dollar appears to dominate it, which means the yuan has been rising even as the currencies of other developing countries fell.

The latest move doesn’t appear to be aimed at helping Chinese exporters even though it follows the weekend announcement of dismal July trade, said Mizuho Bank economist Vishu Varathan.

In a report, Varathan said the yuan has risen by about 3.5 percent per year since 2012 on a trade-weighted basis and the latest change only gives back part of that.

A sustained decline “risks abrasive international trade dynamics,” said Varathan. But he said a weaker yuan “could be ultimately positive for Asia” if it helps to revive Chinese demand for imports.