China does not need a currency freefall. The yuan has since devalued more than 3% against the US dollar, raising fears of further depreciation and capital outflow. The PBOC pointed out the RMB will not continue to depreciate.
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The central parity rate of the yuan weakened by 704 basis points, or 1.1 percent, to 6.401 against the U.S. dollar on Thursday, according to the China Foreign Exchange Trading System. It noted the fixing has shown significant deviation from market spot rate for a prolonged period, weakening its benchmarking function. Candy Ho, HSBC’s global head of Rmb business development tells GTR: “This one-off adjustment is consistent with China’s drive towards a more market-driven exchange rate mechanism”. After the quick aggressive two-day move, it is interesting to see verbal intervention coming in so quickly in favour of stability.
Certainly, there remains considerable uncertainty about how much more flexible the fixing will now be – or how active the PBoC intends to be to stabilize spot prices.
The PBOC has acted as the International Monetary Fund prepares to decide whether the Rmb will be included in its special drawing rights (SDR) group of reserve currencies, along with the US dollar, British pound, the yen and the euro.
The market has been divided on the motivation behind the move. As a result, an unstable RMB might risk undermining these endeavours.
The Chinese currency continued its sharp fall for a third consecutive day on Thursday after the central bank reformed the exchange rate formation system.
The market had anticipated that the RMB Yuan would experience some depreciation, and when the guiding rate was revised, to fully reflect this sentiment the market’s reaction was to bridge the previously accumulated differences between the previous rate and the market rate.
David Beckworth, associate professor of economics at Western Kentucky University (WKU) and former economist at the US Department of Treasury, says China’s move was nearly inevitable because it has been pursuing three conflicting policy objectives, or an “impossible trinity”. Furthermore, the devaluation is likely to be merely the first step toward an eventual floating of the yuan, he says. A statement from the Washington-based fund said: “Greater exchange rate flexibility is important for China as it strives to give market-forces a decisive role in the economy and is rapidly integrating into global financial markets”.
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Yet China so much as budges its FX rate and old bogeymen such as “currency warfare” and the “exporting of deflation” are rushed back out of retirement, and worst-case scenarios are given top billing.
