BEIJING—China’s central bank devalued its tightly controlled currency Tuesday as the world’s second-largest economy continues to sputter.
In an apparent effort to blunt criticism over China’s exchange-rate policy, the People’s Bank of China took the step with an eye toward making the yuan’s value more market-based.
China sets a midpoint for the value of the yuan. In daily trading, the yuan is allowed to move 2% above or below that midpoint, which is called the daily fixing. But Chinese officials sometimes ignore the daily moves, at times setting the fixing so that the yuan is stronger against the dollar a day after the market has indicated it should be weaker.
With Tuesday’s move the fixing will now be based on how the yuan closes in the previous trading session. As a result, the yuan’s fixing was lowered 1.9% Tuesday from the previous day, leaving it at 6.2298 to the U.S. dollar, compared with 6.1162 on Monday.
The central bank said in a statement posted on its website that the yuan’s midpoint has diverged quite a bit from the market rate for a relatively long time and that it was time to make the midpoint more market-based.
“The PBOC has astutely combined a move to weaken the yuan with a shift to a more market-determined exchange rate,” said Eswar Prasad, a Cornell University professor and former China head of the International Monetary Fund.
China’s leadership has been urging the International Monetary Fund to declare the yuan an official reserve currency on par with the dollar, euro, the Japanese yen and the British pound—a move that could raise China’s influence on the world stage just as Beijing increasingly challenges Washington in global affairs.
To that end, the leadership has been resisting an outright devaluation of the currency despite the country’s plunging exports, for fears that a move like that could jeopardize the yuan’s chance of joining the elite group of currencies.
Rather, it chose to do so by giving what the longtime critics of China’s currency policy have long been clamoring for: Let the market play a bigger role in deciding the yuan’s value.
The engineered fall in the yuan is likely to cause political ripples around the world. In particular it may reignite criticism of China’s tight control over the yuan’s exchange rate within the U.S. Congress and some American businesses, which have long said the currency was already too weak and set at a rate that allowed Chinese exporters to sell their goods artificially cheap on world markets.
As recently as April, other central bankers were speaking confidently that China wouldn’t devalue. This puts pressure on them to follow suit.
In a semiannual report about world currency exchange rates published in April, the Treasury Department credited China for allowing the yuan to rise in recent years but also said the currency remained “significantly undervalued” and “that fundamental factors for [yuan] appreciation remain intact, highlighting the need for further strengthening over the medium-term.”
But in May, the IMF said China’s yuan was no longer undervalued for the first time in more than a decade, a milestone in the country’s efforts to open its economy.
The news comes weeks before China’s President Xi Jinping is due to visit Washington for a summit with U.S. President Barack Obama, who has resisted calls to describe Beijing as a currency manipulator during his time in office but is now likely to face new pressure on the currency question.
The move could give a shot in the arm to China’s weakened exports sector, which remains an important part of the economy despite Beijing’s effort to seek growth beyond its traditional sources. On Saturday, Chinese officials said July exports fell a surprising 8.3% from a year earlier. Exports for the first seven months of the year were down 0.8% in dollar terms compared with a year earlier.
The strong exchange rate against the euro has been a drag on China’s exports. The PBOC has kept the yuan steady against the dollar but doesn’t as regularly influence its exchange rate against other currencies, allowing the yuan to follow the dollar’s rise against other currencies like the euro. The latest data showed exports to the European Union fell 12% in July from a year ago.
China’s economic growth in the second quarter came in at 7% year over year, the slowest pace in six years, due to a weak property market and soft domestic demand in addition to exports. China’s cabinet, the State Council, said last month it would offer tax breaks and other incentives to help the trade sector. Other measures Beijing has taken include four rate interest-rate cuts since November to provide funds for domestic companies.
The currency action raises questions about whether China will be able to pull off its shift to an economy oriented toward domestic demand and away from export-led growth.
“The real proof in whether this change is about reform or growth will come when authorities resist the urge to intervene down the road when another policy goal that could be achieved by a significant revaluation or devaluation comes knocking,” said Scott Kennedy, an analyst at the Center for Strategic & International Studies, a Washington think tank.
“China wasn’t able to resist that urge on the stock market, so the government doesn’t get the benefit of the doubt on this quite yet,” Mr. Kennedy said, a reference to China’s recent moves to prevent further declines in its equities markets.
China shares wavered between positive and negative territory after the announcement, a day after Shanghai posted its largest daily percentage gain in a month. The Shanghai Composite Index was last flat at 3929.26 while the smaller Shenzhen market was up 0.7% at 2290.