China set the yuan at its weakest level in more than four years amid currency outflows and a slowing economy.
The central bank is testing how far it can allow market forces to dictate the yuan’s value without setting off a sell-off and angering its trading partners, the Wall Street Journal reports.
“It’s a stress test of sorts,” one source said.
“What the central bank is trying to avoid is the kind of panic selling that resulted from the August devaluation.”
China set the yuan at 6.414 to the US dollar Wednesday, its weakest level since August 2011, continuing a month-long trend and following the market’s lead.
In the past, the setting did not always coincide with where the yuan had last traded in the market as the central bank tightened its grip to stabilize the currency.
Beijing is also bowing to investor pressure to deliver on its pledge of a more market-driven yuan while trying to avoid a repeat of mistakes like its market-roiling summer devaluation.
The heavy sell-off caught People’s Bank of China (PBoC) officials somewhat off guard, according to people close to the central bank.
The yuan has lost as much as 3.4 percent of its value since Aug. 10, the eve of the 2 percent devaluation.
Efforts since then to steady the yuan have been costly.
Internal estimates at the PBoC show that it spent as much as US$130 billion in August alone in bolstering the yuan’s value.
And in recent months, Beijing has tested various ways to intervene to provide traders with forward guidance.
Rounds of monetary easing, deteriorating foreign exchange reserves and a market convinced that China’s currency has only one way to go have left Beijing in a bind.
On one hand, it has vowed to global investors and the International Monetary Fund that it will act to make its currency more market-driven.
On the other, billions of dollars continue to flow out and competing domestic pressures are rising.
“The central bank is in a dilemma right now,” said Zhang Ming, a senior economist at the Chinese Academy of Social Sciences, a government think tank.
Zhang and other analysts now think the yuan is overvalued relative to its purchasing power, forcing Chinese companies to cut prices and lower wages to stay competitive, which could raise the specter of deflation.
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