China Currency Devaluation “Technical Move” And “Less Dramatic Than It Seems”

As U.S. stocks reverse yesterday’s upward path, turning negative today by more than 1 percent during the afternoon and taking the Dow Jones Industrial Average negative on the year, China’s devaluation of its currency is overblown, according to institutional investor reports.

China’s move last night to devalue the renminbi, viewed as an additional measure to prop up its economy by making its exports cheaper, is viewed very differently by both Capital Economics and Cornerstone Macro.

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Capital economics says China currency devaluation technical, not primarily economic issue

In an August 11 China Economics Update, Capital Economics notes that while many analysts have credited a competitive devaluation of the currency as a move to shore up exports, Julian Evans-Pritchard says that the move largely resulted from a “technical change” and was not the result of a major policy shift.

China’s PBOC explained that it was a technical shift in currency valuation that was at issue, Capital Economics pointed out. Instead of adjusting the trading band’s mid-point (between the renminbi and the U.S. dollar) at a rate of its own choosing, the issue is one of allowing the free markets to have a say. The peg is now based off the previous day’s closing rate and overnight shifts in the FX markets. Due to the reference rate being previously set at levels well above the market rate, the new approach naturally meant the reference rate had to be lowered sharply.

PBOC describes currency devaluation as "technical"

The PBOC described the move in terms that speak to a technical adjustment, calling it a “one-off one-time correction to close the gap between the reference rate and the market rate.” Capital Economics believes the changes represent a more transparent reference rate and is part of long-standing reform plans. These plans, market watchers should note, have as their goal more market-driven exchange rate and relax capital controls, the report noted. Rather than reflect a move to more government control, China shows it remains diligent to push forward with financial reform, “particularly ahead of the IMF’s decision on whether or not to include the renminbi in the SDR basket.”

While economic growth concerns might have contributed to the timing of the announcement, they were unlikely to have been the primary consideration in making the move.

Cornerstone: China’s currency devaluation “less dramatic than it seems”

Cornerstone Macro, for its part, calls the Chinese devaluation “less dramatic than it seems,” pointing out that in the near term the People’s Bank of China is likely to fight further weakening because it would only exacerbate capital outflows from the country. They say the Chinese move has lessoned the likelihood of a hard landing in China, which is a net positive for the U.S. economy, US markets and the Fed.

With nearly 2 percent of companies in the S&P dependent on China, the impact of the move is being considered as negligible.  As the Chinese move towards a weaker is potentially setting back their efforts to encourage greater international use of the renminbi, the Cornerstone report noted that devaluing the renminbi is not likely to impact the International Monetary Fund’s moves to grant China reserve currency status.

Capital Economics say the problem was not that Chinese competitiveness on the world stage due to their higher currency that was generally pegged to the appreciating U.S. dollar. They say the issue behind disappointing export performance was subdued foreign demand, not primarily to do with Chinese competitiveness.