Lower exchange rate byproduct, not goal

BEIJING - The central bank on Tuesday revised the yuan's central parity rate formation system to give the market a louder voice, and the market answered - with a sharp fall.

However, the yuan's two percent tumble was a long overdue market reaction rather than a signal of more depreciation by the regulator.

Tuesday's performance should come as no surprise as the yuan has enjoyed reasonable stability over the last few months while the euro, yen and all emerging economy currencies succumbed to the greenback.

The global consensus is that the US dollar will only continue to grow stronger against other currencies. While other economies battle economic lethargy, the US is starting to enjoy a robust recovery and the Federal Reserve is mulling increasing interest rates.

The market had anticipated that the yuan would experience some depreciation, and when the guiding rate was revised -- to fully reflect this sentiment -- the market's reaction was to bridge the previously accumulated differences between the previous rate and the market rate.

China does not need a currency freefall. A weaker yuan may counter a slump in exports, but prolonged depreciation would trigger capital flight, disturb the financial system and slash investors' confidence in the yuan.

The aim is to keep the yuan's exchange rate "stable at a reasonable level", according to a central bank press release related to the central parity rate revision.

Some might say Tuesday's plummet could spook traders into dumping the yuan, especially as the market has now been given a bigger say.

The central banks that control free floating currencies, such as the US dollar, the euro or yen, however, have shown the world what they can do to exchange rates. So, with $3.65 trillion in foreign exchange reserves, the Chinese central bank will be no less competent.

And the fundamentals are still solid.

Although the economy is beset by subdued industrial production and a lackluster property market, measures in the third quarter such as monetary easing, fiscal support, as well as improved real estate sentiment will prop up fixed-asset investment.

Exports are slowing, with an almost 9 percent drop in July, but as imports have declined even more, there are no concerns on the current account surplus front.

China is not waging a currency war; merely fixing a discrepancy. The central parity rate revision was designed to make the yuan more market-driven and in line with market expectations. The lower exchange rate was just a byproduct, not the goal.