China devalues the yuan amid worsening trade slump

China devalued its tightly controlled currency Tuesday following a slump in trade, allowing the yuan's biggest one-day decline in a decade.

The central bank said the yuan's fall was due to reforms aimed at making its exchange rate more market-oriented. But sustained weakness raises the risk of tensions with the United States and other trading partners that criticize Beijing's currency controls.

China becomes the third major trader to take actions that weakened their currencies. Initiatives by Japan and the European Union over the past two years depressed the yen and euro. But analysts cautioned against seeing the change as a direct effort to help Chinese exporters.

The yuan had strengthened along with the U.S. dollar, hurting exporters and raising the risk of politically dangerous job losses in manufacturing industries that employ tens of millions of workers. July exports fell by an unexpectedly large margin of 8.3 per cent from a year earlier.

Tuesday's move "signals a new government willingness" to let the currency decline, said USB economist Tao Wang in a report.

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Beijing is likely to move cautiously but market expectations of further weakening "could quickly become entrenched" and cause the yuan to "depreciate quite quickly and significantly," said Wang. She said that would represent a "sea change in China's exchange rate policy" but would help to support flagging economic growth.

A weak currency helps export-driven economies such as China's — and Canada's — because it makes locally made goods a lot cheaper to international buyers, and thus more likely to be sold abroad.

Beijing is taking the step amid a pesky stock market downturn and broader economic slowdown it can't seem to fix. China has said it expects its economy to grow by seven per cent this year. That would be a robust performance for most developed economies, but in China it's a marked slowdown from recent years.

"Seven per cent growth is a very respectable number but China has been experiencing double-digit growth for many many years," McMaster University finance professor Luke Chan told CBC News in an interview.

"All of a sudden you're growing at  seven per cent. That is a disaster at least from the point of view of the market growth, so they're trying to anything to make sure that by the end of the year they can at least have seven per cent."

Thorny issue

The devaluation could present a dilemma for governments that accuse Beijing of suppressing the yuan's exchange rate, giving its exporters an unfair price advantage and hurting foreign competitors.

A weaker yuan might prompt complaints by foreign manufacturers. But the central bank said its goal was to give market forces a bigger role, a step the United States has demanded.

If the changes help to support Chinese exports, "that could help sustain regional trade and in turn help support global growth," the governor of the Philippine central bank, Amando Tetangco, told The Associated Press.

The yuan, also known as the renminbi, is allowed to fluctuate in a band two per cent above or below a rate set by the People's Bank of China based on the previous day's trading.

The bank said starting Tuesday that in addition to the previous day's exchange rate, the daily fixing of the trading band will take into account supply and demand.

"This complex situation is posing new challenges," said a central bank statement. It said a strong yuan is "not entirely consistent with market expectation" and this was a good time to adjust controls.

The center of Tuesday's trading band was set 1.9 per cent below Monday's level. The yuan quickly fell 1.3 per cent against the dollar and was down 1.9 per cent by the afternoon.

That was the biggest one-day decline since Beijing ended the yuan's direct link to the U.S. dollar in July 2005 and switched to basing the exchange rate on a basket of foreign currencies. The composition of that basket is secret but the dollar appears to dominate it, which means the yuan rose even as currencies of other developing countries fell.

The latest move doesn't appear to be aimed at helping Chinese exporters even though it follows last weekend's announcement of dismal July trade, said Mizuho Bank economist Vishu Varathan in a report.

The yuan has risen by about 3.5 per cent per year since 2012 on a trade-weighted basis and the latest change only gives back part of that, according to Varathan.

A sustained decline "risks abrasive international trade dynamics," said Varathan. But he said a weaker yuan "could be ultimately positive for Asia" if it helps to revive Chinese growth and demand for imports.