“Trust the market, respect the market, fear the market, and follow the market,” the deputy governor of China’s central bank said at a rare press briefing yesterday as the world tried to figure out how far China is prepared to let its currency devalue.
What observers were told is that the central bank will step in when the market is “distorted,” according to comments deputy governor Yi Gong made to reporters.
The People’s Bank of China is trying to soothe international concerns after it devalued the yuan for the third time in three days. Those devaluations have seen the currency’s biggest one-day slide - on Tuesday - and sent shockwaves through global stock markets.
The unexpected rate cuts have puzzled international observers, with experts saying that China is putting the desire to jump-start its slowing economy ahead of its hopes to gain broader acceptance of the yuan.
A weaker yuan makes China’s exports cheaper, giving domestic companies an advantage in international markets. But wild currency fluctuations make international investors less likely to rely upon the currency for transactions, which would help give China a more active role in the world economy as the guarantor of a key currency.
Trading is still an important driver of the GDP growth and a lower currency rate will lead to a favourable balance of trade.
The main purpose of the decision was to slow capital outflows, since the movement of assets out of the country is considered a sign of an unstable economy. Weakening the currency means a yuan holder has to move a lot more money outside China to buy the same amount of goods.
Part of the problem is that it’s still unclear to the outside world if China was in full control of the yuan’s devaluation or whether the collapse in value took it by surprise.
While the International Monetary Fund has praised China for allowing the market to play a freer role in setting exchange rates, experts say Chinese authorities would retain strict control over the yuan.
“China does not follow a free-floating currency regime and it is known that China’s central bank closely controls the value of the yuan,” said Arie Gozluklu, assistant professor of finance at the Warwick Business School.
With such comments in mind, analysts were sceptical about the central bank’s announcement that it would apply a new methodology to determine the standards it uses to fix rates, ones that are more responsive to domestic and international market conditions and foreign exchange demand and supply.
“How flexible the yuan will be will really depend how it could help to recover the Chinese economy,” said Zheng Chaoyu, professor of economics at the People’s University in Beijing.
But even if the country settles upon an acceptable yuan rate, the mere fact that it allowed the yuan to fall so far so fast has sparked worries that its actions could prompt other countries to also devalue their currencies to keep their exports competitive, in effect sparking a trade war.