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China further devalues yuan, sparks fears of currency war

business Updated: Aug 12, 2015 19:13 IST
Chinese yuan

A customer counts Chinese Yuan notes at a market in Beijing, August 12, 2015. China shocked global markets on Tuesday by devaluing its currency after a run of poor economic data, a move it billed as a free-market reform but which some experts suspect could be the beginning of a longer-term slide in the exchange rate. (REUTERS)

Faced with sluggish economic growth and dwindling exports, China on Wednesday devalued its currency for the second consecutive day, sending fresh shockwaves through global markets and fuelling fears of a currency war as jittery Asian neighbours came under pressure to devalue as well.

The central parity rate of renminbi, or yuan, weakened by 1,008 basis points, or 1.6%, to 6.3306 against the US dollar, narrowing from yesterday's 2%.

Tuesday's devaluation, the first since 1994, was effected amid slowing down of the world's second largest economy which is hovering around 7% and falling exports.

The cuts have jolted global share and commodity markets while Asia-Pacific currencies have suffered. Analysts said the move threatens to spark off a currency war as other countries may come under pressure to devalue.

Neighbouring Vietnam announced it was widening the band in which its own currency, the dong, is allowed to fluctuate each day from 1% to 2%. This would allow the dong to depreciate faster.

The move sent fresh shockwaves through markets round the world but the People's Bank of China (PBOC), the central bank, has sought to calm fears, saying it was not the start of a sustained depreciation.

In a latest statement released on Wednesday, the PBOC said the rate changes are normal, as it shows a more market-based system and the decisive role that the supply-demand relationship plays in determining the exchange rate.

"This may lead to potentially significant fluctuations in the short run but after a short period of adaptation the intra-day exchange rate movements and resulting central parity fluctuations will converge to a reasonably stable zone," the PBOC said.

The International Monetary Fund (IMF) described devaluation of Chinese currency as "a welcome step" that allows market forces to have a greater role in determining the exchange rate.

"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," an IMF spokesperson was quoted by the official Xinhua news agency.

The IMF said it believes China can achieve an effective floating exchange rate system within two or three years.

However, the move still surprised the market and prompted the lowest valuation of yuan since October 2012.

Ma Jun, chief economist at the PBOC's research bureau, attributed the lower rate to a long-standing gap between the central parity rate and previous day's closing rate on the inter-bank market.