Yuan reset - killing two birds with one stone?

Many market observers linked the central bank’s move to the recent release of trade figures showing that exports from China fell by over 8 per cent in July, continuing months of decline, apart from a slight improvement in June. 

Certainly the high yuan hasn’t been helpful for China’s exports. The yuan has been one of the strongest-performing currencies in the world, rising by around 14 per cent over the last 12 months on a trade-weighted basis. 

However, another factor may also have been behind the central bank’s move. Earlier this month, the IMF said it was delaying including the yuan in the SDR basket of reserve currencies because it was not yet freely tradable.

It is notable, then, that the IMF welcomed the PBOC move for allowing market forces to play a greater role in determining the exchange rate and helping to “clear some technical hurdles for the yuan to join the SDR”.

The PBOC emphasised that the adjustment was a one-off move and not the beginning of a downtrend – a statement greeted with scepticism by many commentators. 

Reuters suggested the yuan could be headed for a 10-per-cent drop while Yale economist Stephen Roach said it would take a lot more than a 1.9-per-cent cut – the immediate impact of the adjustment – to kick-start Chinese exports. He suggested that this could be the beginning of a widespread currency war and that “the race to the bottom just got a lot more treacherous”.

Indeed the PBOC talked up the market to support the yuan from falling further. PBOC chief economist Ma Jun said the PBOC has the resources it needs to intervene if needed “to prevent exchange-rate fluctuations caused by irrational herd behaviour”. 

The State Administration of Foreign Exchange asked banks to limit dollar purchases and at least one major state agency sold a large amount of dollars. These actions helped prop up the yuan.

South Korea, a major trading partner of China, welcomed the yuan depreciation, saying it should help both China’s economy and its own exporters. Its won experienced one of the biggest falls after the PBOC move, dropping nearly 2 per cent, while the ringgit and rupiah also declined over 1 per cent. The Thai baht slipped, but not by as much as the currencies of other Asian and emerging markets.

By the end of the week, the yuan appeared to have stabilised at 6.40 to the dollar, while currency markets seemed to have recovered from the shock. 

As Macquarie economist Larry Hu suggested in an interview with the Wall Street Journal, the PBOC will hit two birds with one stone, as the weaker yuan will support exports (although some time will be needed to achieve that) while helping China to achieve reserve currency status.