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Yuan devaluation boosts Chinese shares, hurts other markets

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Authorities lowered the yuan's central rate against the US dollar by nearly five percent in a single week, which should make Chinese exports cheaper on world markets

Authorities lowered the yuan's central rate against the US dollar by nearly five percent in a single week, which should make Chinese exports cheaper on world markets (AFP Photo/-)

Hong Kong (AFP) - China's central bank on Tuesday devalued its yuan currency by nearly two percent against the US dollar, as authorities seek to push market reforms and bolster the world's second-largest economy.

A cheaper yuan will make Chinese exports cheaper potentially boosting overseas sales, among the main drivers of growth during the nation's remarkable rise over the past three decades, but which have recently shown signs of weakening.

The surprise move marked the biggest drop since China reformed its currency system in 2005 by unpegging the yuan -- also known as the renminbi (RMB) -- from the greenback.

But analysts said the devaluation could prompt an angry reaction from the US, which has consistently argued that the yuan is undervalued, and put downward pressure on other Asian currencies.

The People's Bank of China (PBoC) set its daily "reference rate" for the yuan at 6.2298 to $1, compared with 6.1162 yuan on Monday, effectively 1.86 percent lower.

China allows the yuan to vary by up to two percent from the central rate each day. Until now Chinese officials said they based the fixing on a poll of market-makers, but the PBoC said Tuesday they will now also take into account the previous day's close and other factors.

Beijing has so far kept a tight grip on the currency's value on fears major swings and volatile capital flows could raise financial risks and reduce its control over the economy.

That has made the yuan far more stable than other major global currencies and a two percent move in its value is dramatic: before Tuesday's announcement it had traded within a roughly 0.4 percent band for four months, which one analyst described as a "straight line".

- 'Major step' -

But China is also seeking to reform its yuan policy in an effort to have it included in the International Monetary Fund's basket of "special drawing rights" (SDR) reserve currencies.

Its controls have been a stumbling block in gaining admittance to the select group, now comprised of the US dollar, Europe's euro, British pound and Japanese yen.

The Washington-based IMF said this month that "significant work" still needed to be done for the yuan to be considered before its next review in November.

"A reasonable adjustment of the RMB's value is good for China's exports and also good for the RMB to be admitted to the SDR," Liu Dongmin, director of international finance research office at the Chinese Academy of Social Sciences, told AFP.

"But most importantly, this marks key progress for RMB exchange rate reform since 2005 and a major step for RMB marketisation," he said.

Even so, the US has long argued the yuan has been kept "significantly undervalued" to help Chinese exporters, and Shanghai Finance University associate professor Qin Huanmei said Washington was likely to object to the depreciation.

"The value drop of yuan against the US dollar will put pressure on the US because it wants the yuan to appreciate, which would help with its trade," she told AFP.

The PBoC described the sharply lower rate as a one-off move, though it did not use the term devaluation, saying the weakening in the currency reflected the new method of calculating the daily price.

The bank will now "comprehensively consider the supply and demand of foreign exchange" as well the latest international market rates for foreign currencies to set the fixing, according to a statement.

- Caution seen -

Despite the reform, analysts said the government's long-promised goal of free currency convertibility probably remained distant.

"We think it unlikely that the Chinese government will let only market momentum drive the RMB exchange rate from now on, as that can be quite destabilising," Wang Tao, head of China economic research at UBS, said in a research report.

She forecast the yuan would weaken to around 6.5 to the greenback by the end of the year.

On Tuesday afternoon, the yuan was quoted at 6.3195 to the dollar, down sharply from Monday's close of 6.2096, according to the operator of the national foreign exchange market.

The move sent ripples through Asia's currency markets, sending the Australian dollar -- often seen as a proxy for the yuan -- tumbling more than one percent. The greenback also gained against the South Korean won, Indian rupee, and Japanese yen.

Analysts said Customs data released over the weekend showing July exports plunged 8.3 percent from a year earlier -- deepening a trade slump and spelling more worry for the economy -- supported the case for a lower yuan, which they said was overdue.

China's gross domestic product expanded 7.4 percent in 2014 -- its weakest pace since 1990 -- and has slowed further this year, growing 7.0 percent in both the first two quarters, in-line with the government's annual 2015 target.

The benchmark Shanghai stock index closed nearly flat on Tuesday, as investors mulled the devaluation's impact.