Is China moving towards currency reform or competitive devaluation?

A move towards exchange rate reform, weaker growth, and a looming Fed hike all likely played a role in the recent CNY move. News of a possible third Greek bailout passed largely unnoticed this week and instead, investors have been riveted by the 3-4% decline in the RMB against the USD and related communication from the PBoC.

A research note from Barclays explains that there are two schools of thought on why China chose to act now. One is that the country is merely moving towards a market-based exchange rate mechanism, given its hopes for SDR inclusion, RMB internationalization and capital account liberalization. The timing was probably influenced by the PBoC’s wanting to prevent further RMB appreciation in REER terms as a possible Fed hike nears in September. After all, the RMB has appreciated 15-20% on most REER models in the past few quarters, as other currencies have lost ground against the USD. The other school of thought (which includes many vocal investors) attaches a deeper meaning to the move. These investors believe that China is pulling the ’competitive devaluation’ trigger because the economy is slowing more quickly than official data imply and are often skeptical of official Chinese statistics. Despite authorities efforts of propping up stock markets, new infrastructure investments, and cutting local rates, the market has failed to move meaningfully. They are now turning to a weaker currency.

Slowing growth and RMB appreciation certainly played a role in the current decision, especially since market pricing was pointing in the same direction. But as PBoC Chief Economist Ma Jun noted on Thursday, China will intervene to prevent “irrational herd behavior” and sees no reason for continued depreciation. 

"We do not believe that China plans to depreciate the currency massively (20-30%) for competitiveness reasons, but do expect another 6-7% depreciation by year-end.," according to the Barclays research note.