China reduced outside value of its currency (updated with comment of IMF, dvpt. up to Aug. 13, 2015)

China  unexpectedly reduced the outside value of its currency

Beijing is hoping that a more flexible currency will help stabilize China’s sputtering economy. But this monetary high-wire act carries enormous risk.

In a shock move, China on August 11, 2015 set the yuan’s central parity, the rate around which it is permitted to trade against the U.S. dollar, 2% lower. The People’s Bank of China also said it will base the daily rate more on market conditions, a heavy hint that the currency will be allowed to fall further.

This will take some pressure off Chinese exporters. The yuan has been basically fixed against the U.S. dollar since March, but it has appreciated against other global currencies, eroding competitiveness.

Chinese imports have been even weaker than exports, though, largely due to falling commodity prices. As a result, China’s trade surplus in the first seven months of the year actually doubled, to USD 306 billion. This suggests the trade balance wasn’t the primary motive for the currency move.

China’sdevaluation of its currency jolted global markets Tuesday, hitting stocks and commodities and boosting government bonds.

The S&P 500 fell 0.7% in early trade. The pan-European Stoxx Europe 600 index was down 1.5% early afternoon. Oil prices also fell sharply, while demand for haven assets pushed down bond yields in the U.S. and Europe, as investors worried that Beijing’s move signaled growth concerns over the world’s second-largest economy.

Shockwaves from China’s yuan devaluation will be felt by all kinds of investors, and will likely prompt questions from U.S. politicians.

Financial markets have reacted to signs that Chinese authorities believe it is necessary to act to boost flagging growth, said Ewen Cameron Watt, chief investment strategist at BlackRock’s Inc.’s Investment Institute. “For markets today it’s a case of shoot first, ask questions later,” said Mr. Watt, whose firm oversees $4.7 trillion in assets.

A weaker yuan could hurt the competitiveness of firms outside China by making their goods and services relatively more expensive, while companies that generate sales in China could find revenue and profit generated in yuan are worth less in their home currency.

“Worries about what this might mean for the competitiveness of the West versus the East” are driving the stock market selloff, said Chris Jeffery, an asset-allocation strategist at Legal & General Investment Management.

Shares of companies that export to China, including luxury-goods firms, car makers and mining companies, came under the most intense pressure.

In Europe, shares in LVMH Moët Hennessy Louis Vuitton and Gucci-owner Kering SA fell more than 3%. Premium auto makers BMW AG and Daimler AG both lost more than 4%, dragging Germany’s export-heavy DAX index to a 2.0% decline. Shares in BHP Billiton  PLC were down 3.9% andRio Tinto PLC lost 2.1%.

Commodity prices, which are sensitive to Chinese demand, fell. Brent crude oil was down 2.4% at $46.16 a barrel.

Yields on 10-year U.S. Treasury bonds fell 0.07 percentage point to 2.15%. The equivalent German yield fell a similar amount to 0.60%. Yields fall as prices rise.

Most Asian stock exchanges and curriencies decreased. Japan’s Nikkei 225 index fell 0.4%. The Shanghai Composite Index ended flat.
On August 12, IMF The international Monetary Fonds issued the following statement: “The new mechanism for determining the central parity of the Renminbi announced by the PBC appears a welcome step as it should allow market forces to have a greater role in determining the exchange rate. The exact impact will depend on how the new mechanism is implemented in practice. Greater exchange rate flexibility is important for China as it strives to give market-forces a decisive role in the economy and is rapidly integrating into global financial markets. We believe that China can, and should, aim to achieve an effectively floating exchange rate system within two to three years. Regarding the ongoing review of the IMF’s SDR basket, the announced change has no direct implications for the criteria used in determining the composition of the basket. Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the Renminbi were included in the currency basket going forward.”
We would like to add that Chinese Central bank stopped the fall but the Renminbi is continuing to fall the third day in row with the aim that Chinese exports become less costly and other effects already described above.

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