After years of steadily strengthening its currency, China has decided that it would rather use the yuan to boost its economy after all.
That’s the decision it made today (Aug. 11) when the People’s Bank of China (PBOC) devalued the yuan by 1.9% against the dollar. The yuan fell to 6.32 against the dollar by early afternoon in China, from 6.21 on Monday, marking a three-year low for the currency, and the biggest one-day drop in 20 years.
The move was unexpected—coming after years of currying favor with trading partners who had complained about China’s artificially-weakened currency—but the motivations behind it are clear. A general slowdown in China’s economy has been compounded by a 8.3% fall in exports in July from a year earlier, with shipments to Japan and the European Union dropping by double-digit figures. A cheaper yuan will help make Chinese exports more attractive.
The yuan had begun to look comparatively expensive against other Asian currencies, because the PBOC supported the currency’s value while China’s neighbors have steadily devalued their own currencies throughout the year. Some analysts suggest that the currency’s nominal effective exchange rate had risen 13.5% this year, causing some to call for a devaluation.
A suddenly cheaper yuan has had plenty of knock-on effects already, and poses a small but significant danger to economic stability at home and abroad. Shares in major Chinese airlines—Air China, China Eastern, and China Southern—each dropped by more than 4% in Shanghai and over 10% in Hong Kong, on concerns that the effective cost of importing fuel will rise. Shares in China’s export companies rose.
The switch also sent other regional currencies lower too, and this could be the start of a longer-term problem with what the PBOC currently calls a “one-off” move. The Australian, New Zealand and Taiwan dollars, plus the South Korean won and the euro are all down against the US dollar, which essentially reduces the effectiveness of China’s own currency devaluation.
One more concern is that other Asian countries competing with China for export value may retaliate by further devaluing their own currencies, potentially drawing China into a currency war that could have knock-on effects for global inflation levels.
Optimists in that scenario will point to the fact that the PBOC said that today’s devaluation will not be repeated; for the pessimists, it should be remembered that less than three months ago, the central bank was making it absolutely clear that any devaluation was unnecessary.