Will The Yuan’s Fall Force China To Re-Energize Reforms? by [email protected]

Minyuan Zhao and Avery Goldstein discuss the yuan devaluation

China’s move last week to allow the yuan to shed value by nearly 3% against the U.S. dollar is a step towards market-determined currency rates, although stability remains doubtful. At a broader level, the devaluation trains attention on China’s growth model and the unsustainable practices it needs to unlearn, say experts.

Between Tuesday and Thursday of last week, China’s central bank — the People’s Bank of China — allowed the yuan to fall to its lowest level against the dollar in four years. The bank typically controls the currency’s movement by permitting trades within a specified range of a reference rate it sets daily.

The yuan’s devaluation caused a selloff in global stock markets and commodity markets, triggered by fears that China could launch a currency war to boost its sagging exports. However, the central bank intervened on Friday by raising its reference rates in an attempt to prevent a panic downward spiral.

Then on August 18, the markets responded negatively again. The yuan, which had been slipping further since the initial devaluation, dropped a further 0.2%, a move that came in tandem with a 6.2% plunge in the Shanghai Composite index. The fundamental concerns trace back to uncertainty over the state of China’s slowing economy. And given the sharp drop in the equity market, concerns grew that the currency could fall further.

Piecing together the reasons behind the government’s original action, meanwhile, brings out a number of diverse views.

Reading into the Fall

“Strip away the rhetoric, and the devaluation is in response to the miserable July trade figures,” said Marshall W. Meyer, Wharton emeritus professor of management and a longtime China expert. In July 2015, Chinese exports fell 8.3% over those of a year ago — the worst in four months — with depressed demand from Europe and the U.S., and was far worse than the 1% fall economists had predicted. “The intent is to jump start the export engine. Whether it will — given soft global demand — is an open question,” Meyer noted.

“Devaluing the currency is the easy way out; it immediately makes exports more competitive,” said Mauro Guillen, Wharton professor of international management and director of The Lauder Institute. China had been losing ground due to rising wages and to competition from other Asian countries, he explained. “China needs to rely less on exports and more on domestic consumption. That’s the essential structural shift.”

See full article here.

Yuan Moves RMB