China shocked financial markets for the second day in a row on Wednesday, reducing the reference yuan – U.S. dollar exchange rate by 1.625. This action follows an almost 2% adjustment to the yuan – dollar rate on Tuesday.
According to a statement from the People’s Bank of China, the daily fix that sets the value of the Chinese currency against the greenback was reduced for the second consecutive day to 6.3306 yuan, down from 6.2298 on Tuesday.
Financial markets were stunned by the move and down by as much as 1-2% globally. This is not surprising given the PBoC flat out lied in their Tuesday statement when they claimed the initial rate adjustment was a “one-off” situation. However, the Chinese central bank continued to deny it would depreciate the currency in its Wednesday statement. That said, several analysts (including UBS and Citibank) have recently published reports suggesting the PBoC will likely continue its “external stimulus” by further depreciating the yuan.
Of note, China still keeps close control of its currency, but the country has promised for several years to transition to a market-oriented system. The ongoing FX interventions by the PBoC, however, expose this claim as yet another lie by the clearly untrustworthy Chinese government.
Yuan devaluation increases worries about the health of the Chinese economy
These two consecutive currency devaluations by the PBoC have increased worries regarding the health of the world’s second-largest economy.
The move was generally seen by economists and analysts as a method to boost exports as economic growth slows, and many argue the central bank is not done yet.
The renminbi devaluation hammered global financial markets markets, with markets falling worldwide on Wednesday as investors fretted about the possibility of a hard landing for China’s economy.
China trying to get yuan into IMF's SDR currency basket
Analysts also point out China would like to see the yuan included in the IMF's basket of "special drawing rights" reserve currencies.
The IMF has said more changes were needed with China's proposal for inclusion in the SDR basket
, but a fund spokesperson welcomed Tuesday's move, saying the new policies should allow market forces "a greater role in determining the exchange rate".
"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," the IMF spokesperson continued. "The exact impact will depend on how the new mechanism is implemented in practice."
Citi says yuan - dollar exchange rate will move to 6.5
In a report published on August 11th, Citi Research argues that the Chinese authorities will gradually work the U.S. dollar - Chinese yuan exchange rate down to 6.5.
Minggao Shen and colleagues at Citi highlight that as of Tuesday, FX market makers are required to submit their quotations by referencing to the closing rate of the previous day. Moreover, the analysts say that despite PBoC's claim it will not intervene further in the rate, they anticipate further interventions. "In our view, this regime shift implies the beginning of the measured RMB depreciation. We thus expect the USDCNY to hit 6.5 in next 12m (~4.2% depreciation based on today’s fixing of 6.2298) with increased volatility."