China – devaluation smoke and mirrors

Managing the renminbi via a trade weighted index can be seen as part of the economic reform process. It makes sense to move to such a system as domestic interest rates and the capital account are being progressively liberalised. By allowing greater flexibility in the exchange rate at the same time as the capital account is made more convertible, the PBOC would be free to focus monetary policy on achieving domestic targets such as inflation or GDP growth. There are risks however. Moving to a TWI based exchange rate system steepens the path of depreciation against the US dollar, which for a central bank already battling capital flight is a dangerous step. While we continue to target a 12-15% devaluation against the dollar next year, the odds of a sharper and faster adjustment are higher under a TWI system than the previous crawling US dollar peg.

To read the full report - Login or Subscribe