China’s surprise move to devalue the yuan has far-reaching impacts

BEIJING—China’s surprise August 11 move to devalue its currency has intensified concerns about a slowdown in the world’s second-largest economy, whose growth rate has reached a six-year low. It is also fanning political tensions with the United States and Europe, whose exports could become comparatively costlier.

China’s central bank said the devaluation of the yuan was a result of reforms intended to make its exchange rate more market-based. The yuan is linked to the dollar’s value, which has jumped in the past year.

Chinese officials say the move will mean the yuan will partly reflect market fluctuations while still remaining linked to the dollar.

A tight peg between the dollar and the yuan has hurt Chinese exporters by keeping their goods expensive overseas, thereby threatening jobs in key manufacturing industries. Exports in July plummeted by an unexpectedly steep 8.3 per cent from a year earlier. A cheaper yuan will lower the prices of China’s exports.

“The move signals that (China) is willing to use all available tools, including a weaker currency, to prop up exports and its domestic economy,” said Eswar Prasad, an international economist at Cornell University.

Yet many economists cautioned against seeing Beijing’s move mainly as an effort to benefit its exporters at the expense of overseas competitors. They note that China’s currency, left to market forces alone, would have declined in value in recent months.

“It is a small step forward to accommodating market forces,” said Sung Won Sohn, an economics professor at the California State University’s Smith School of Business.

The yuan, also known as the renminbi, is allowed to fluctuate two per cent above or below a rate set by the People’s Bank of China based on the previous day’s trading.

The bank said that starting Tuesday, in addition to the previous day’s exchange rate, the daily fixing of the trading band will take into account supply and demand.

The centre of Tuesday’s trading band was set 1.9 per cent below Monday’s level. The yuan quickly fell 1.3 per cent against the dollar and was down 1.9 per cent by the afternoon.

China’s economic growth has slowed to an annual rate of just 7 per cent—healthy for most countries but far below the double-digit pace it has enjoyed for decades. The country’s leaders fear that growth below that pace will raise the unemployment rate and possibly lead to social unrest.

Still, China’s action sparked ire in Washington, where members of Congress have long complained that Beijing manipulates its currency to gain a trade advantage.

“For years, China has rigged the rules and played games with its currency,” said Sen. Chuck Schumer, a New York Democrat. “Rather than changing their ways, the Chinese government seems to be doubling down.”

The Treasury Department’s response was more measured.

“While it is too early to judge the full implications of the change… China has indicated that the changes announced today are another step in its move to a more market-determined exchange rate,” a department statement said.

China becomes the third major economy to act to lower its currency value. Initiatives by Japan and the European Union over the past two years depressed the yen and euro.

But the decision has added to worries over slowing growth in the world’s second-largest economy, pulling shares and prices of oil and other commodities lower. Here’s a rundown of impacts:

Keeping Score: The Chinese yuan’s market rate fell 1.8 per cent after Tuesday’s nearly 2 per cent decline, which was the biggest drop in a decade. Germany’s DAX dropped 2 per cent to 11,071.06 and Britain’s FTSE 100 lost 1.4 per cent to 6,574.15. France’s CAC 40 shed 1.7 per cent to 5,012.38. Wall Street looked poised for further losses, with both Dow and S&P futures down 0.9 per cent.

Devaluation: The International Monetary Fund welcomed Beijing’s move toward more flexible exchange rates, but many investors saw it as an attempt to stimulate a slowing economy, since a cheaper yuan will benefit China’s exports by making them less expensive overseas. The devaluation triggered selling of shares, oil and other commodities on expectations of weaker demand from China.

Vietnam Follows Suit: Vietnam doubled the trading band of its currency Wednesday to 2 per cent allow it to weaken following China’s devaluation. The State Bank of Vietnam said the weaker Chinese currency would have a “negative impact” on its economy. But analysts said the move was unlikely to spur competitive devaluations and would have only a modest impact.

Asia’s Scorecard: Japan’s Nikkei 225 fell 1.6 per cent to 20,392.77 and Hong Kong’s Hang Seng dropped 2.4 per cent to 23,902.51. South Korea’s Kospi lost 0.6 per cent to 1,975.47 and Australia’s S&P/ASX 200 slipped 1.7 per cent to 5,382.10. The Shanghai Composite Index fell 1.1 per cent to 3,886.32, and shares in Southeast Asia were also lower.

Energy: U.S. crude fell 3 cents to $43.05 a barrel in electronic trading on the New York Mercantile Exchange. It fell Tuesday to its lowest level in six years, losing $1.88 to $43.08 a barrel. Brent crude, a benchmark for international oils used by many U.S. refineries, rose 12 cents to $49.30. It fell $1.23 to close at $49.18 in London.

Currencies: The dollar fell to 124.37 yen from 125.18 yen in the previous trading session. The euro rose to $1.1118 from $1.1047.

Those moves contrast with action foreseen from the Federal Reserve, which is expected to boost the short-term interest rate it controls later this year. A Fed rate hike would likely raise the value of the dollar, which has already jumped about 14 per cent in value in the past 12 months against a basket of foreign currencies.

The rising dollar has hurt North American exporters by making their goods costlier abroad, and China’s move to devalue its currency could further complicate the Fed’s decision on when to raise rates. By making Chinese goods comparatively cheaper in the United States, a lower-valued yuan would contribute further to already-low U.S. inflation.

The Fed wants to be “reasonably confident” that inflation is returning to its 2 per cent target before raising rates. Inflation has risen just 1.3 per cent in the past 12 months.

Michael Feroli, an economist at JPMorgan Chase, suggested that the dollar’s rise poses a concern for some Fed officials who have been reluctant to raise rates. Should the U.S. economy stumble in the coming weeks, “dollar strength would only further embolden the doves at the next meeting” in September, Feroli said.

Still, Feroli said, “we think this a minor stumbling block for a September” rate increase.

China’s currency move unnerved global investors Tuesday. U.S. stocks tumbled, with the Dow Jones industrial average sinking 213 points by late afternoon.

USB economist Tao Wang said Beijing would likely move cautiously, but investor expectations of further weakening “could quickly become entrenched” and cause the yuan to “depreciate quite quickly and significantly.”

She said that would represent a “sea change in China’s exchange rate policy” but would help to support flagging economic growth.

Rugaber contributed from Washington. AP Economics Writer Paul Wiseman in Washington and AP Writer Teresa Cerojano in Manila also contributed to this report.