This has fueled talk of a currency war, where countries use exchange rates to keep their products competitive on global markets. Read More. However, the People's Bank of China says the policy change was made in response to market forces, which will be allowed more control over the currency in the future. So what's going on?
Analysts seem divided on whether this is the start of a more flexible currency regime for China or an old-style devaluation. It appears to be a bit of both. China's economy has been struggling and a weaker currency would give it a boost, although most commentators say a steeper fall would be needed for a real impact.
Expert: We don't know China's real motivations Mitul Kotecha, senior foreign exchange strategist at Barclays Capital in Singapore, says it's a "revolutionary move" and will allow the market a greater hand in determining the yuan's value. It was the first time the U. However, the U. According to then-U. China's main justification for devaluing the yuan in was the rise of the U.
Other reasons included the country's desire to shift toward domestic consumption and a service-based economy. While fears of further devaluations continued on the international investment scene for another year, they faded as China's economy and foreign exchange reserves strengthened in The negative impact of currency devaluations on relations with the U.
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Consistent with Markets. Impact on Global Trade Markets. The US move came on Monday, after the currency fell below 7 yuan to the US dollar for the first time since Beijing has previously sought to prevent the currency from slipping below the symbolic level. The escalation of the trade war, sparked by fresh US tariff threats , is seen to have prompted the policy shift. On Monday, the People's Bank of China PBOC said the slump in the yuan was driven by "unilateralism and trade protectionism measures and the imposition of tariff increases on China".
The yuan is not freely traded and the government limits its movement against the US dollar. Unlike other central banks, the PBOC is not independent and faces claims of interference when big moves occur in its value. Capital Economics Senior China Economist Julian Evans-Pritchard said by linking the yuan's devaluation to the latest tariff threats, the PBOC has "effectively weaponised the exchange rate, even if it is not proactively weakening the currency with direct intervention".
A weaker yuan makes Chinese exports more competitive, or cheaper to buy with foreign currencies. From the US perspective, it is seen as an attempt to offset the impact of higher tariffs on Chinese imports coming into America. While it appears a win for consumers around the world - who can now buy Chinese products more cheaply - it carries other risks.
In , the fluctuation band was only 0. Then, it was 0. However, the central value of those bands is still set by the central bank. Capital controls have become increasingly weaker over the years. Before , Chinese companies were prohibited from having dollars.
Chinese citizens were also prohibited from making international trade transactions in Chinese currency and exporting currency outside of China. Therefore, it was almost impossible for a company outside of China to have yuan, and it was also very difficult for a Chinese company to have dollars.
As a result, all international transactions had to pass through the central bank, which could set the price that it deemed appropriate for its currency. Since , China has released current account transactions, of which most are trade transactions.
However, the restrictions on capital movement are still very intrusive. This implies that since the commercial flows have exerted pressure on the price of the yuan, although financial flows do not yet have that capacity even though financial operations are often disguised as commercial operations with the goal of evading the capital controls.
In return, some capital controls have been eliminated in China. This move aims to establish the Chinese yuan as a reference currency in international trade and as a reserve currency for other central banks. It is assumed that China is seeking a gradual liberalization of capital controls while it simultaneously stops intervening in the exchange market in order to complete its transition to a free floating regime. Since , the yuan has decreased in value against the dollar.
The exchange rate has gone from 6 yuan per dollar to 7 yuan per dollar in August , a devaluation of It is the recent movement of the yuan that is prompting the complaints from Washington. If there are pressures on the exchange rate to appreciate, this means that the central bank must buy dollars in the market and sell yuan.
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