China Shocks The Currency Markets By Devaluing Yuan

China has been holding the Yuan steady for many years now. But yesterday Chinese Central Bank shocked the currency markets. The People’s Bank of China allowed the yuan to depreciate almost 2 percent against the U.S. dollar to levels last seen three years ago, sending a shock through currency markets.

This step is not going to make everyone happy. China has been facing economic problems with its exports going down. The dramatic devaluation — even if it is a one-time event — is likely to draw intense criticism from some quarters. The U.S. has long accused China of keeping its currency artificially low by hoarding foreign reserves, instead of allowing it to move freely in foreign exchange markets.

In Asia, some are likely to see the move as a sign that China is weakening its currency intentionally, possibly in reaction to very weak export data released over the weekend. A weak currency cheapens the price of a country’s exports, making them more attractive to international buyers by undercutting competitors.

China has been trying hard to make Yuan an international reserve currency with the blessings of IMF. IMF is likely to vote soon to make Yuan a reserve currency giving it SDR rights.

“The gain by holding dollar-yuan very steady, in terms of its appeal for the SDR, is now outweighed by the need for a weaker exchange rate as part of looser monetary conditions,” said Sean Callow, a strategist at Westpac Banking Corp. in Sydney. “It adds to the appeal of the U.S. dollar heading into next month’s meeting.”