The objective of the regime change of the Renminbi (or Yuan) seems twofold: 1) to reform the Yuan exchange system to bring it closer to "market" mechanisms; 2) stimulate the economic growth of the country, which is now in trouble, favoring the recovery of exports. As regards the first point, the PBoC has the objective of making the Renminbi gain the status of Reserve Currency; to this end it is necessary that the calculation of the fixing (official exchange value) be determined by market forces (ie by commercial banks) and by the PBoC.
In the past, the IMF has seen a constant mismatch between the policy rate (published by the PBoC) and the daily spot rate (at which the banks trade). In addition, the PBoC also stated that it intends to introduce further measures to open its foreign exchange market to foreign operators and to better align the offshore and onshore markets. Indeed, the IMF has commented favorably on the Chinese initiative, even if it has indicated 2-3 years as the necessary period for a correct transition from an administered exchange rate regime (such as the crawling peg vs. US dollar adopted so far) to a free one fluctuation.
But there is clearly another, more important reason behind the PBoC's move, and that is the intention to stimulate, or at least not damage, Chinese economic growth. A backlit reading of the devaluation confirms the suspicion that China's growth is lower than that officially reported by government statistics, and the latest data on exports was probably the classic straw that broke the camel's back, prompting the authorities to this surprise move to support the economy.
On the other hand, the Yuan's peg to the US dollar had led to a significant appreciation (about 12,5%) in real effective terms (against the basket of commercially relevant currencies). So a partial decoupling from the US currency was economically justified. Analyzing the maneuver with a cool head, we have serious doubts about the effective effectiveness of this maneuver. Indeed, it is not certain that a devaluation of the currency will automatically lead to a recovery in economic growth through a strong recovery in exports.
In this regard, we recall that Chinese net exports are worth only 2.7% of GDP (this value is only apparently low because China is both the largest exporter and importer in the world, ed), while domestic consumption is worth more than 38% of Chinese GDP (investments are instead worth 47% and constitute the first item of Chinese GDP, ed). Furthermore, thinking about the past experiences of other economies in the Asian area, we have repeatedly found that the weakness of the currency does not guarantee exports higher.
Indeed, although Asian currencies are weak by historical averages against the US Dollar, this has not resulted in a boost to exports for those economies, as the slowdown in the economic outlook in Asia has been driven by other reasons, i.e. loss of competitiveness, drop in world demand and contraction in world trade.
Therefore, we believe further stimulus measures are likely, including a couple of cuts in reserve requirement (RRR) rates, an interest rate cut, a further currency devaluation maneuver (albeit limited, as mentioned) and more fiscal measures aimed at growth in infrastructure investment. At the same time, growth is expected to remain subdued due to long-term structural trends: overcapacity and deflation will continue to cast a shadow on the Chinese economy.
