China's long march to currency reform takes a step forward

China's currency devaluation is a step in the long march to a more open regime for the yuan, analysts say, but authorities will need to further loosen their controls to promote long-term growth.

The central bank on Tuesday unveiled a near two percent devaluation of the yuan, saying the move was part of broader economic reforms aimed at moving towards a more flexible exchange rate.

The suddenness and scale of the devaluation in a normally stable unit rocked global financial markets, as investors took it as a sign the world's second-largest economy is performing worse than revealed, and sparked worries China had fired the first shot in a currency war.

It also compounded jitters over China's financial health after a debt-fuelled stock market bubble burst in June, following a 150 percent surge in the previous 12 months.

China's central bank soothed markets by setting the daily reference rate of the yuan -- also known as the renminbi (RMB) -- against the US dollar marginally higher on Friday, ending an almost five percent fall over three days.

Analysts cheered the move towards a more market-based Chinese currency, but said other reforms had become more urgent as the Asian giant seeks a more sustainable growth model in the face of a slowing economy.

"Reducing overvaluation of the RMB is a welcome change that eliminates one source of unnecessary self-inflicted pain," the Asian Development Bank's chief economist Shang-Jin Wei said Friday.

ANZ Banking Group's chief economist for Greater China, Liu Ligang, hailed the move as "very important" but said more reforms, such as freer capital flows, liberalising interest rates and more allowing financial products to hedge against risk, were still needed.

If the bank had acted sooner, the impact on the economy would be "more obvious", he told AFP.

- 'Killing two birds' -

The People's Bank of China (PBoC) used to decide its daily yuan refence rate by polling market-makers, but will now consider the previous day's close, foreign exchange supply and demand and the rates of major currencies.

The yuan is restricted to trading up or down two percent from the daily rate, although the State Council, the cabinet, has signalled it does intend to broaden the trading band.

China is currently bidding to join the International Monetary Fund's basket of reserve currencies, but the Washington-based lender has said more reforms are needed for membership.

Beijing is "killing two birds with one stone: it can release depreciation pressure to help the economy grow and meet the IMF's requirement of letting the yuan be more market-oriented", Zhang Ning, a Hong Kong-based economist for UBS, told AFP.

The yuan devaluation has also been seen as a means for authorities to help the slowing economy by boosting exports -- a key driver of China's extraordinary rise in the past three decades.

For the Henry Parts company in the eastern city of Ningbo, the devaluation means more orders from foreign customers for its machinery components.

"The devaluation will increase our revenue and we can get the orders we couldn't get before," manager He Zhanyong told AFP.

China's economy expanded 7.4 percent last year, its weakest since 1990, and has slowed to 7.0 percent in each of the first two quarters. The government wants growth of around 7.0 percent for all of 2015.

- Currency war -

Still, there are worries the move could set off a "currency war" as regional neighbours and other emerging market countries face pressure to devalue to stay competitive.

"To some extent, the PBoC has served as an anchor in the region and the move now allows other currencies to weaken further," Societe Generale Group said in a research report.

Asia-Pacific currencies this week suffered their biggest two-day selloff since 1998, during the Asian financial crisis, while Russia's ruble slid to a six-month low.

A disorderly devaluation could hamper Beijing's push for greater global stature for the yuan and the government's pursuit of a bigger say in world finance, typified by its role setting up two new multilateral banks for Asia and the BRICS nations, which also include Brazil, Russia, India and South Africa.

Argentina has nearly $34 billion in foreign exchange reserves but about a quarter are denominated in yuan and their value declined after the Chinese devaluation, Bloomberg News reported.

Chinese central bank officials have denied a currency war was the intention, but have been more cagey about the timetable for further reforms to the yuan.

Asked if China was on track to open its capital account to investment flows this year, as previously pledged, one official said the process would be orderly.

"China's schedule for capital account convertibility is steadily advancing," PBoC Deputy Governor Yi Gang told a news conference on Thursday. "We will proceed in an orderly way according to our own schedule to realise it."