PBC dispels fears of continuous drop
China's currency, the yuan, was devalued against the dollar for a second consecutive day, stoking fears of a global currency war, but the central bank said there was no basis for a sustained yuan devaluation.
Following a surprise 2 percent devaluation on Tuesday, the People's Bank of China (PBC), the country's central bank, again weakened the central parity rate of the Chinese yuan by 1,008 basis points to 6.3306 against the US dollar on Wednesday, marking its weakest level since October 11, 2012.
In the mainland spot market, the yuan fell to 6.39 per dollar Wednesday, a loss of 2.86 percent over the past two days; while in offshore trading, the yuan dipped to 6.59 against the greenback as of press time.
The PBC said the fluctuations are normal, which show the market has been playing a decisive role in setting the exchange rate.
In a statement published on its official website on Wednesday, the PBC said the 1.6 percent devaluation of the central parity rate on Wednesday is based on a new way of calculating the central guiding rate. According to the new method, the market will offer quotes based on the previous day's closing rate, the daily foreign exchange supply and demand as well as the movement of major currencies. The yuan closed at 6.32 per dollar on Tuesday, sliding 1.5 percent from the day's official rate of 6.23.
Amid worries that the yuan will slide further in the near future, the PBC said that there is no basis for continued yuan devaluations both domestically and globally, citing the country's sound macroeconomic environment, massive trade surplus and ample foreign exchange reserves.
According to a Reuters report citing foreign exchange traders, the central bank tried to reassure the spot yuan market on Wednesday by letting State-owned banks sell dollars on behalf of the PBC to keep the yuan at around 6.43.
"Under the new mechanism, the central parity rate will refer to the previous day's closing rate, thus increasing the relevance of the daily yuan rate and making it better reflect market forces," Wang Tao, chief China economist at UBS AG, told the Global Times on Wednesday. "And a more market-driven exchange rate may help make the yuan more qualified to be included in the Special Drawing Rights (SDR), international reserve currencies used by the International Monetary Fund (IMF)."
The IMF will review whether to include the yuan in the SDR later this year.
Financial markets hit
The two-day devaluation sent shock waves throughout financial markets, driving gold prices near a three-week high.
In mainland stock markets, airline shares suffered the most with those of China Eastern Airlines and China Southern Airlines each dropping by about 6 percent on Wednesday as investors fear the negative impact of the devaluation on sectors with heavy dollar-denominated debt. Textile and garment shares rose as a weaker yuan is expected to help exports.
The second consecutive devaluation continued to affect Wall Street. Shares of US automakers heavily exposed to the China market fell. General Motors, Ford and Fiat Chrysler were all down 1 to 4 percent, reported Reuters on Wednesday.
Apple, whose second-largest market is in China, fell 1 percent to $112.32. The company's shares already fell 5.2 percent on Tuesday.
Currencies tumble
Meanwhile, global currencies also tumbled on Wednesday, which sparked fears of a global currency war.
According to a Reuters report, the Indonesian central bank "heavily" intervened to defend the rupiah on Wednesday after its currency fell to its weakest level since 1998, while the South Korean won fell to its lowest in almost four years and the Australian dollar slumped to its weakest level since 2009.
"Whether currencies of competing countries would weaken to support exports would largely depend on whether China can properly manage its exchange rate reform so that the yuan will not slide uncontrollably," Liu Yuhui, a professor at the Chinese Academy of Social Sciences, told the Global Times.
Stabilizing trend
"The yuan may continue to weaken in the short term, but it doesn't mean the currency has entered into sustained devaluation," Huang Yiping, deputy dean of the National School of Development at Peking University, told the Global Times.
Wang echoed Huang's view, saying that the yuan still faces downward pressure, but in the long run, China's high trade surplus will stabilize the yuan's exchange rate.
"Even with the exchange rate reform, maintaining the yuan's stability remains one of the policy targets, so the yuan exchange rate will continue to fluctuate," she said. "We expect the yuan to mildly weaken against the greenback within the year.
According to a UBS forecast, the yuan is estimated to drop to 6.5 against the dollar by the end of the year, and 6.6 at the end of 2016.
Reactions:
IMF
"The new mechanism for determining the central parity of the renminbi announced by the PBC appears a welcome step as it should allow market forces to have a greater role in determining the exchange rate."
- IMF statement
Russia
"It is unlikely that the decision of the Chinese authorities will have a strong impact on the Russian market, because the volume of mutual settlements in yuan is only 7 percent, and we compete with China in almost none of the product groups." - Alexander Gabuev, head of Russia in the Asia-Pacific region program at the Moscow Carnegie Center.
U.S.
"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. Any reversal in reforms would be a troubling development."
- a U.S. Treasury official
South Korea
"We are keeping close tabs on the movement of the currency market. The Chinese currency change increased the won's volatility, coupled with a possible US rate hike."
- Finance Minister Choi Kyung-hwan
