China’s currency moves

By Mark Mobius, Templeton Emerging Markets Investment Trust 

After a volatile month for China’s stock market in July, currency moves made news in August. On August 11, the People’s Bank of China (PBOC) made an adjustment that sent the yuan to its lowest rate in three years versus the US dollar. The next day, another adjustment was made, causing the currency to fall to 6.33 per US dollar.

The currency devaluations followed a report that showed a drop in exports in July. Thus, the currency weakening allowed by the PBOC was seen by some commentators as an attempt by the Chinese government to help drive exports, since a weaker currency makes China’s goods more globally competitive.

The recent action in China’s stock market and its currency has caused a heightened attention to Chinese government policy decisions. The decline in the currency (officially called the renminbi/RMB) triggered currency depreciations in a number of other countries, as well as declines in a number of global equity markets. All this attention certainly demonstrates how important China has become within the global economy at large.

Devaluation—or a market-driven move?

Once pegged to the US dollar, the renminbi exchange rate has been allowed to float since 2006 within a specified range around a fixed base rate or midpoint the PBOC determines. This range or margin has been adjusted periodically and was fixed at a 2% per day maximum rise or fall.

The central bank had total control over where the midpoint was set, but it announced that going forward, it would change how the currency’s daily trading band would be calculated. After Tuesday, August 11, the midpoint would be based on the previous day’s closing price.

China has stated the currency adjustments were made in attempt to move to a more market-driven exchange rate. It has embarked on a program to make the economy more market oriented, which means relaxing many of the restrictions it has had, including widening the range in which the currency can trade. Less than two years ago, the maximum range of currency movement was at a much tighter 1% up or down.

China’s currency operates under a managed floating exchange rate regime. The market rate is expected to fluctuate around the central parity, which serves as the benchmark exchange rate.

Announcing its recent actions, the PBOC stated that market trading forces should help correct divergence between the market rate and the central parity, but since the third quarter of 2014, China’s significant trade surplus and the appreciation of the US dollar against other major currencies have affected the RMB exchange rate in different ways.

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