Yuan devaluation is part of overall currency reforms in China

PUBLISHED : Thursday, 13 August, 2015, 1:27am
UPDATED : Thursday, 13 August, 2015, 1:27am

The yuan hit a four-year low yesterday, falling for a second day after the central bank devaluated the currency by 1.9 per cent on Tuesday. The move aims to boost the country's declining exports, but many pundits are already warning against triggering a currency war. Their alarm is premature. As the People's Bank of China said in its statement, the latest adjustments will help further liberalise the currency. This is a key point that is often lost in alarmist discussions.

It's certainly not a coincidence that the 1.9 per cent devaluation, the biggest one-day change in a decade, came after poor weekend data indicating exports were down by a whopping 8.3 per cent last month and that producer prices were into their fourth year of deflation. China's informal peg to the US dollar, in place since it started a managed float in 2005, has caused the yuan's relative strength to work against its exporters. The latest drop will bring some relief to long-suffering exporters but will be most unwelcome to China's key trading partners, hence the resentment and ringing of alarm bells. But are the warnings overblown?

The yuan has been under pressure for months to weaken because of massive capital outflows. The move this week should ease the pressure somewhat. Beijing hopes to reassure the markets by saying the devaluation is a one-off operation. Markets remain to be convinced. Most major Asian currencies have hit multi-year lows. Stock markets in Asia were a sea of red yesterday.

Still, we must not disregard the stated purpose of the easing, which is to reform the yuan. Beijing has one eye on the International Monetary Fund, which will review whether to include the yuan as a formal reserve currency later this year. The latest changes mean the PBOC will no longer set the value of the currency wherever it likes. Instead, it will allow greater market forces to determine its value by referring to its closing rate on the previous day.

Beijing has good reasons to boost exports and carry out more currency reforms. Most of its trading partners have seen their currencies slide since the onset of the 2008 global financial crisis and the subsequent sharp appreciation of the US dollar. Meanwhile, since 2005, the yuan has gone up by more than 30 per cent. Instead of taking China for granted as the good Samaritan while everyone else is locked in a race to the bottom, they should learn that the yuan is not a one-way bet.