China’s new mechanism for determining the central parity of its currency “appears a welcome step” as it should allow market forces to have a greater role in determining the exchange rate, the IMF has said.
The global financial institution also asserted that China should aim to achieve an effectively floating exchange rate system within two to three years.
China devalued its tightly-controlled currency on Tuesday by two per cent, the biggest one-day fall since a massive devaluation in 1994, as the world’s second largest economy grappled with economic slowdown and dwindling exports.
The “new mechanism” for determining the central parity of the Renminbi announced by China “appears a welcome step” as it should allow market forces to have a greater role in determining the exchange rate, an IMF spokesperson said.
Noting that the exact impact will depend on how the new mechanism is implemented in practice, the IMF said greater exchange rate flexibility is important for China as it strives to give market forces a decisive role in the economy and is rapidly integrating into global financial markets.
“We believe that China can, and should, aim to achieve an effectively floating exchange rate system within two to three years,” the spokesperson said in a late night statement on Tuesday.
Regarding the ongoing review of the IMF’s SDR (Special Drawing Rights) basket, “the announced change has no direct implications for the criteria used in determining the composition of the basket”, the spokesperson said in response to a question.
“Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the Renminbi were included in the currency basket going forward,” the spokesperson said.
According to Wall Street Journal, devaluation of Chinese currency would help it increase its export and will pressure China’s direct trade rivals, such as South Korea and Japan, to follow suit and let their own currencies fall.
“It raises risks of market volatility in other emerging market economies. More broadly it sends a signal to investors that policy makers in China and elsewhere are straining for tools to address the problem of slow growth,” the daily said.
The New York Times explained that China took such a decision for its economy to remain on an even keel, keeping growth and employment high and for its currency to become globally pre-eminent, helping promote the country’s diplomatic goals and solidifying the country’s centrality to the global economy.