Corporate Finance

China’s Central Bank Devalues Yuan

China's foreign-exchange reserves slid $300 billion over the last four quarters.
Katie Kuehner-HebertAugust 11, 2015

The People’s Bank of China Monday cut its daily reference rate by 1.9% and said devaluing the yen would help the currency become more aligned with supply and demand in an effort to boost exports, Bloomberg reported.

“The announcement suggests policy makers are now placing a greater emphasis on efforts to combat the deepest economic slowdown since 1990 and reduce the government’s grip on the financial system,” Bloomberg wrote. “Authorities had been propping up the yuan to deter capital outflows, protect foreign-currency borrowers, and make a case for official reserve status at the International Monetary Fund.”

China’s foreign-exchange reserves slid $300 billion over the last four quarters in large part due to the central bank’s exchange-rate intervention, according to Bloomberg. It also made the yuan the best performer in emerging markets, which contributed to last month’s 8.3% slide in exports.

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Market-makers who submit prices for the central bank’s reference rate will have to consider the previous day’s closing spot rate, foreign-exchange demand, and supply, the PBOC said. The central bank also said it would stabilize market expectations and ensure the new reference-rate mechanism will take effect “in an orderly manner.”

Bloomberg Intelligence chief Asia economist Tom Orlik wrote in a note that China has to balance the need to boost exports against the risk of capital outflows. Orlik estimated that a 1% depreciation in the real effective exchange rate boosts export growth by 1 percentage point with a lag of three months. At the same time, a 1% drop against the dollar triggers about $40 billion in outflows.

China’s move has raised the risk of a “currency war” as export rivals seek a weaker exchange rate to stay competitive, Stephen Roach, a senior fellow at Yale University and former non-executive chairman for Morgan Stanley in Asia, told Bloomberg.

“It’s hard to believe this will be a one-off adjustment,” Roach told Bloomberg. “In a weak global economy, it will take a lot more than a 1.9 percent devaluation to jump-start sagging Chinese exports.”