In a surprise move Tuesday, China let its currency, the renminbi (RMB), fall to three-year lows, further feeding fears for China’s already slowing economic growth and stirring concern for other global markets and worries of possible currency wars.
The People’s Bank of China (PBC) devalued the renminbi, or yuan, nearly 2 percent against the U.S. dollar, calling the move a “one-time correction.” Some economists felt the move was meant to give China’s exporters a break by making their goods cheaper on the world market, but others indicated a different motivation: Because the Asian powerhouse’s currency maintains a close relationship to the U.S. dollar, when the dollar jumps against world currencies, the yuan rises against China’s trading partners’ currencies too.
China has wanted the yuan to rise steadily against trade-weighted partners and experts say the currency might have to be devalued some to ensure the uptick is gradual.
“All China is doing today is managing the pace of trade-weighted renminbi appreciation,” Jonathan Anderson of Emerging Advisors Group told Fortune. “Any attempt to gain truly meaningful competitiveness vis-à-vis trading partners would require, say, a 20 percent to 40 percent devaluation against the dollar.”
In a statement outlining why now was a good time to improve the yuan’s relationship against the dollar, the PBC said the U.S. dollar is strengthening while the euro and Japanese yen are weakening, and emerging markets and commodities currencies are facing downward pressure—all of which pose new challenges.
“As China is maintaining a relatively large trade surplus, RMB’s real effective exchange rate is relatively strong, which is not entirely consistent with market expectation. Therefore, it is a good time to improve quotation of the RMB central parity to make it more consistent with the needs of market development,” a PBS spokesperson explained.
The bank said recently the yuan’s central parity, which serves as the benchmark of China’s exchange rate—a midpoint from which the spot rate can fluctuate by 2 percent above or below—has deviated from the market rate and that improving the market maker’s quotation will make the country’s financial system more market oriented.
That midpoint moved Tuesday from 6.11 yuan per U.S. dollar to 6.22.
The PBC said it will be monitoring the marketing closely and that the market will play a bigger role in exchange rate determination, implying that it would play a smaller one.
Despite the bank’s levelheaded outlook on the intentional depreciation, the move has caused a ruckus in the market.
U.S. stock indices dipped more than 1 percent and stocks in Asia and Europe took a hit too.
The Malaysian ringgit and the Indonesian rupiah hit lows level with the Asian financial crisis 17 years ago, according to Reuters, and the U.S. dollar gained 2.2% against Brazil’s real.
The depreciation also drove oil prices 2.7% lower to $49.03 after big gains Monday.
China’s move may have stoked fears of competitive devaluation in international markets, but analysts say it’s too early to peg the devaluation as evidence of an impending currency war.