China devalues yuan after poor economic data

By Pete Sweeney and Lu Jianxin

SHANGHAI (Reuters) - China devalued its currency on Tuesday after a run of poor economic data, a move it billed as a free-market reform but that some suspect could be the beginning of a longer slide in the exchange rate.

The central bank set its official guidance rate down nearly 2 percent prior to market open to 6.2298 yuan per dollar - its lowest point in almost three years - from 6.1162 the previous day in what it said was a change in methodology to make it more responsive to market forces.

"Since China's trade in goods continues to post relatively large surpluses, the yuan's real effective exchange rate is still relatively strong versus various global currencies, and is deviating from market expectations," the central bank said.

"Therefore, it is necessary to further improve the yuan's midpoint pricing to meet the needs of the market."

The central bank called it a "one-off depreciation", but economists were divided over the significance of a move that appears to reverse the recent policy of maintaining a strong yuan, which has buttressed policy goals of boosting domestic consumption and outward investment.

"For a long time I gave the PBOC credit for holding the line on the renminbi and recognising that while it might be tempting to try to shore up the old growth model by devaluing the currency, that really was a dead end," said economist Patrick Chovanec.

Chovanec allowed that a weaker yuan might better reflect current market demand, but he said the strong yuan served a more important goal of forcing "painful" economic transformation toward consumption and away from low-end manufacturing.

"What the world needs from China is not more supply; what it needs is demand."

Other economists said the move could, however, address a frustration among currency traders with the government's heavy hand in the market, and pointed out that nearly all of China's neighbours had debased their currencies while China held firm.

While cutting the exchange rate will not address all the ills of China's export sector, which is hobbled by rising labour costs and quality problems, Guo Lei, economist at Founder Securities in Shanghai, said it would help relieve deflationary pressure, a far bigger economic concern.

Data released at the weekend showed China's exports tumbled 8.3 percent in July, hit by weaker demand from Europe, the United States and Japan, and producer prices are well into their fourth year of deflation.

Collapsing prices for global commodities have been blamed for the producer price deflation, putting the country at risk of repeating the deflationary cycle that has blighted Japan for decades.

Growth in China, the world's second-largest economy, has slowed markedly this year and is set to hit a 25-year low even if it meets its official 7 percent target.

Tuesday's move sparked declines in the offshore yuan market and in currencies including the Australian dollar and the Korean won, and caused airline shares to fall, given the impact higher fuel prices will have on their bottom line. Share in exporters rose.

Some said the move was also to blame for a fall in futures contracts tracking the S&P 500 index , given the potential hit to U.S. exports to China. [UD:nL3N10M1TC]

MONEY MANAGEMENT

The spot yuan was changing hands at 6.3185 in mid-afternoon, 1.46 percent away from the midpoint.

Under the current regime, the spot yuan is allowed to rise or fall by 2 percent from the midpoint each day.

In the past, the central bank set the midpoint by a formula based on a basket of currencies, but the methodology was never publicised and many believed the midpoint was frequently used as a way to bend the market to policy goals.

Under the new method, investors moving assets out of yuan could take the rate lower in the weeks ahead, raising the possibility of competitive currency depreciations worldwide.

The yuan had been locked in an extremely narrow intraday range since March, varying only 0.3 percent. On Tuesday, the spot yuan price touched its weakest point since September 2012 in early trade.

However, some economists said the move was not just a reaction to the export figures and was linked to Beijing's push for the yuan to be included in a basket of reserve currencies known as Special Drawing Rights (SDR), which are used by the International Monetary Fund to lend money to sovereign borrowers.

"The PBOC aims to move the renminbi to a freer floating and accessible currency, prerequisites for it to be given the IMF’s reserve stamp of approval and will see it move in a wider band," said Angus Campbell, analyst at FXpro.

The IMF proposed in a report this month to put off any move to add the yuan to its benchmark currency basket until after September 2016, and it gave mixed reviews of Beijing's progress in making key financial reforms to its currency market.

(Additional reporting by Samuel Shen and Kazunori Takada in SHANGHAI and Vidya Ranganathan in SINGAPORE; Editing by Mark Bendeich and Will Waterman)

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