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China devalues currency by 2 per cent

11 Aug 2015
Financial Nigeria

Summary

Recent data has shown China's falling exports and a slowing manufacturing sector.

Chinese currency

China devalued its currency, the yuan, by nearly two percent, a move that has sent shockwaves through global markets. In what the People’s Bank of China called a “one-off depreciation,” the yuan was allowed to weaken by nearly two per cent in an effort to boost China’s slowing economy.

Recent data has shown China's falling exports and a slowing manufacturing sector. By the move on Tuesday, China hopes to fight its worst economic slowdown since 1990. The 1.9 per cent reference rate cut is part of efforts make the world’s second largest economy’s exports cheaper and borrowing costs lower.

The move triggered the biggest fall of the currency since January 1994, when China ended its dual-currency system. The yuan dropped 1.8 percent to close at 6.3231 per dollar in Shanghai. It slid 2.6 percent to 6.3790 in Hong Kong’s offshore trading, the biggest discount to the onshore spot rate since 2011.

News of the devaluation of the yuan rattled global markets. The currencies of South Korea, Australia and Singapore fell at least by 1 percent. European luxury goods companies and carmakers were among the hardest hit. China is an important export market for European luxury goods. Carmaker BMW's shares fell 2.7% in early trading while luxury goods group Swatch and LVMH both weakened by more than 3%. Burberry, the British luxury group, was one of biggest fallers in the FTSE 100, sliding 2.9%.
 
Meanwhile, shares of Chinese airlines sank on concern dollar debt costs will rise, while commodities retreated as speculations arose that yuan weakness will erode the buying power of Chinese consumers.

China's foreign-exchange reserves depleted over the last four quarters by $300 billion as a result of exchange rate intervention. The yuan’s real effective exchange rate -- a measure that’s adjusted for inflation and trade with other nations -- climbed 13 percent over the last four quarters and was the highest among 32 major currencies tracked by Bank for International Settlements indexes.

The People’s Bank of China said market-makers who submit prices for the PBOC’s reference rate will, henceforth, have to consider the previous day’s closing spot rate, foreign-exchange demand and supply, as well as changes in major currency rates, the central bank said in a statement. Previous guidelines made no mention of those criteria.

Tuesday’s devaluation shouldn’t be interpreted as a sign that the yuan will enter a depreciation trend, as it was more of a one-off adjustment. The central bank said it will stabilize market expectations and ensure the new reference-rate mechanism will take effect “in an orderly manner.”

The PBOC said Tuesday that a strong yuan puts pressure on exports and cited a high effective exchange rate as a factor behind the devaluation. July’s export slump was deeper than economists predicted, while the nation’s index of producer prices declined 5.4 percent, the most since 2009.

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


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