China: PBOC devalues yuan to shore up external sector; stock market turmoil persists
August 25, 2015
The People’s Bank of China (PBOC) recently unexpectedly devalued the yuan’s daily fixing rate by 1.9% from 6.12 CNY per USD to 6.23 CNY per USD, which represented the largest single-day depreciation since 1994. Moreover, the PBOC announced a significant change in the way the daily midpoint fixing is set. Instead of being defined by the authorities, from 11 August, the PBOC will determine the CNY fixing according to the previous day’s market closing rate, along with demand and supply in the foreign exchange market.
With this move, the PBOC will address the discrepancy between the daily fixing and the actual spot rate observed in the last few months, as the latter has been consistently moving within the upper end of the yuan’s trading band. The exchange rate is allowed to fluctuate 2.0% above or below the daily midpoint fixing that the PBOC sets. In the same statement, the Bank vowed to accelerate the development of the FX market, expand FX products, extend trading hours, promote the formation of a single exchange rate in both on-shore and off-shore markets, among other announcements.
Overall, this move is widely seen as another step toward a more market-determined exchange rate and as a move intended to strengthen the case for the Chinese yuan to be included in the special drawing rights (SDR) basket in September 2016. On 3 August, the IMF staff that is working on the revision of the SDR basket stated that they will propose to the Executive Board that the current valuation of the basket be postponed for nine months to 30 September 2016. IMF officials criticized in the accompanying report that the fixing rate could not be considered as a representative exchange rate for the yuan.
The deprecation of the CNY will also encourage the external sector, which has been hit by the strong appreciation of the yuan in real effective exchange rate terms following the sharp rally of the U.S. dollar against most emerging market currencies. Against this backdrop, analysts warned that the recent weakening of the yuan could prompt China’s export rivals to also adjust their exchange rates, thereby entering into a phase of a currency war that could threaten the global recovery.
Following the 11 August move, the PBOC intervened in the foreign-exchange market in an attempt to protect the yuan from excessive depreciation. As a result, the yuan has remained broadly stable at around 6.39 CNY per USD in recent days, which represents a weakening of 3.0% compared to the exchange rate observed before the devaluation. This situation raised skepticism regarding whether authorities will allow the yuan to trade more freely.
Meanwhile, turmoil persisted in China’s stock markets. After remaining broadly stable in the first weeks of August, the Shanghai Stock Exchange Composite Index (SHCOMP) fell sharply on 21, 22 and 24 of the same month. In fact, on 24 August, the SHCOMP tumbled 8.5%, which represented the largest daily decline since 2007. While the SHCOMP erased all gains that had been made so far this year, the index is still 43.2% above the level observed one year ago. The steep fall that has been tallied in recent days mostly reflected fears that the economy is faring worse than had been expected. According to some analysts, August’s devaluation of the yuan and recent weak economic data corroborate this position. Moreover, investors suggested that Chinese authorities should act more decisively to prop up growth and shore up financial markets.
FocusEconomics Consensus Forecast panelists expect the Chinese yuan to trade at 6.52 per USD by the end of this year. For 2016, the panel projects that the CNY will trade at 6.57 per USD.
On 25 August, the PBOC decided to cut the main policy rates by 25 basis points. Effective from 26 August, the one-year lending rate will be 4.60%, while the one-year deposit rate will be 1.75%. Moreover, the Bank unveiled a cut to the reserve requirement ratio for big lenders by 50 basis points to 18.0%, effective from 6 September.
FocusEconomics Consensus Forecast panelists had not yet taken into account the recent cuts and thus expected the one-year lending rate and the one-year deposit rate to end the year at 4.70% and 1.84%, respectively. For next year, the panel sees the benchmark lending rate at 4.71% and the benchmark deposit rate at 1.85%.FocusEconomics Consensus Forecast panelists expect the Chinese yuan to trade at 6.51 per USD by the end of this year. For 2016, the panel projects that the CNY will trade at 6.57 per USD.