China’s yuan devaluation: What is it worth?

China cut the value of its yuan currency against the US dollar for the second day in a row Wednesday, taking the reductions to 3.5 percent this week — the largest in more than two decades.

The move has reinforced concerns about the world’s second largest economy, and analysts are divided over the reasons behind the move and the consequences it will have.

– Why is China doing this now? –

The People’s Bank of China (PBoC) said Tuesday’s “one-time correction” in the yuan is part of a larger scheme to give the market a bigger say in the value of the currency, also known as the renminbi (RMB).

At the same time Chinese growth has been slowing, and a devaluation can boost the economy by making exports — a key sector — cheaper for overseas buyers.

– Where does the yuan stand internationally? –

A decades-long boom has turned China into the world’s second-largest economy, but despite being the world’s largest trader in goods its role in the global financial system remains relatively limited.

It has been looking to build up its presence, setting up a new multilateral Asian Infrastructure Investment Bank, and is also pushing to join the exclusive club of the International Monetary Fund’s basket of “special drawing rights” (SDR) reserve currencies. But it must show progress on liberalising the yuan regime to win membership.

– How does China’s foreign exchange mechanism work? –

The yuan is generally far more stable than most major currencies.

The China Foreign Exchange Trade System — which operates the national foreign exchange market — and the central bank carry out a poll of market makers to set a daily reference rate, also known as the central parity rate.

The yuan is allowed to move up or down two percent from it each day.

Officials will now also consider the previous day’s close, foreign exchange supply and demand and the rates of major currencies when setting the fix.

– Is this a devaluation? –

Yes and no. China did not use the term devaluation to describe Tuesday’s drop, which it called a “one-time correction”, and said Wednesday’s fall was also a reflection of the new system. But the market widely viewed the move as a devaluation.

“Of course, the PBoC is unlikely to call a devaluation a devaluation, given the political sensitivities around currency wars,” Capital Economics said in a research report.

– What are the effects? –

The jury is still out. For China, the move could deliver both an export and economic boost — but will also make imports more expensive, potentially pushing up inflation, and raise costs for Chinese firms with dollar-denominated debt.

For the rest of the world, some analysts believe the move could trigger currency wars, as other emerging market countries devalue to compete. Market and economic turmoil could cause the United States to delay plans to raise interest rates as the world’s biggest economy recovers.

– How have financial markets reacted? –

The sudden nature of Tuesday’s announcement caught the market by surprise, and the scale of the devaluation — the biggest in more than two decades, although small by global standards — triggered falls in global stock markets and drove the US dollar higher.

Commodities and oil have weakened, partly on fears slowing Chinese growth will leave it needing fewer raw materials.

– How do others feel about the move? –

The United States has previously criticised the yuan for being undervalued, but also hopes China will speed financial reforms and create a more level playing field for American companies. It is taking a wait-and-see attitude.

The IMF, now considering China’s application for SDR currency status, praised the move as giving market forces a greater role.

– Where is the yuan headed? –

Most analysts expect the yuan to weaken further, but at a more gradual pace. SG Global Economics said in a research report that it saw a “bias for further depreciation” in the yuan, extending to five percent over 12 months.