China's decision to devalue the renminbi was greatly misunderstood
Yu Yongding says China's adjustment of the yuan was not about boosting exports; it was driven by a desire to reform the exchange-rate system
The People's Bank of China lowered the central parity rate of the renminbi by 1.9 per cent on August 11, sending shockwaves around the globe. Many foreign commentators condemned the devaluation as a blatant attempt to boost exports - a move that would, they warned, spark new currency wars. But there is good evidence that this was not China's motivation at all.
In fact, China knows currency wars are self-defeating. During the 1997 Asian financial crisis, its economic situation was much worse than it is today, but the government still resisted the temptation to devalue the yuan, and the country emerged virtually unscathed. Today, a devaluation would probably do little for China's trade surplus.
Moreover, China now holds a massive volume of overseas assets and liabilities. As devaluation causes businesses' debt burdens to grow in renminbi terms, the risk of non-performing loans and bankruptcies rises.
For China's monetary policymakers, reforming the exchange-rate system, while preventing depreciation from getting out of hand, poses a serious challenge
Beyond an awareness of the short-term risks of competitive devaluation lies Beijing's commitment to its longer-term goal of shifting the export-based growth model to one driven by domestic consumption.
Given these factors, it seems likely that the recent devaluation was driven by a different goal. This is backed by the announcement on the same day as the devaluation that the yuan's central parity rate will align more closely with the previous day's closing spot rates. This suggests the devaluation was aimed primarily at giving markets a greater role in determining the renminbi exchange rate, with the goal of enabling deeper currency reform.
But this shift carries serious risks. If the renminbi were to depreciate by, say, 2 per cent every day, it would quickly lose 20 per cent of its value - enough to cause a panic and send the exchange rate into a tailspin. That is why the PBOC has retained the right to influence the reporting of offer prices by market makers and intervene directly in the market.
This is what the PBOC did on August 12-13, when stronger-than-expected depreciation pressure and surging devaluation expectations raised the risk that the planned one-off exchange-rate adjustment could trigger a rout. It showed the yuan is under significant depreciation pressure, which is likely to intensify.
For China's monetary policymakers, reforming the exchange-rate system, while preventing depreciation from getting out of hand, poses a serious challenge. For the rest of the world, encouraging China to loosen its grip over the exchange rate, even as the yuan nosedives, is an equally serious imperative. Neither side can afford to fail.
