In the midst of its already slowing economy, China has driven its yuan to the lowest levels since 2011 and now the country’s central bank wants to take a step bank and see to what extent market forces can determine the currency’s value.
Since its initial 2 percent devaluation in August this year, China’s yuan has lost as much at 3.4% of its value.
The People’s Bank of China’s (PBC) latest move to minimize its influence on the exchange rate is being called a stress test. According to The Wall Street Journal, a source familiar with the matter said, “What the central bank is trying to avoid is the kind of panic selling that resulted from the August devaluation.”
On Wednesday China set the yuan at 6.414 against the U.S. dollar, a four-year low.
When the country surprised the world with its August yuan devaluation, it roiled markets and caused a sizeable sell-off. Now the bank is at once working to achieve a more market-driven yuan without setting markets in a tizzy as it did over the summer.
Since August, the PBC has undertaken a host of efforts to boost the currency’s value, and those efforts have so far cost China as much as $130 billion, according to WSJ.
Some analysts have said the yuan is now overvalued relative to its purchasing power and that Chinese companies have had to reduce prices and wages to keep competitive, which could lead to deflation.
The head of trading at a Guangzhou-based bank told WSJ, “What has happened in the past few days shows a clear intention from the authorities that they would like to see an orderly and mild depreciation of the yuan,” adding, “Everything, ranging from the dismal trade data to the prospect of a Fed rate increase, calls for a weaker yuan. If you ask 10 traders in China, nine will tell you that they expect the currency to depreciate in the near term.”
Late last month, the International Monetary Fund (IMF) decided to include the yuan in its basket of reserve currencies, called the Special Drawing Right (SDR), alongside the U.S. dollar, the euro, the yen and the British pound. The move means as of Oct. 1, 2016, China’s yuan will have a supplementary reserve asset that can be exchanged for freely usable currencies.
“The inclusion of the RMB in the SDR basket will increase the representativeness and attractiveness of the SDR, and help improve the current international monetary system, which will benefit both China and the rest of the world,” the People’s Bank of China said following the news.
China can’t afford to devalue its currency too drastically considering it is working to drum up foreign investment and that a cheaper yuan in a U.S. election year could incite criticism that the country is keeping its currency artificially low to aid its exporters, WSJ noted.
For now, the PBC said China will keep its currency at relative equilibrium and that the bank only plans to intervene in cases of excessive volatility.