Asian markets tumbled Wednesday as participants continued to digest Tuesday's surprise move by the People's Bank of China to loosen the ties binding the renminbi to the dollar in favor of a more market-driven approach to exchange rates.
Major stock markets in the region lost ground, with Japan's Nikkei 225 index falling 1.58%; China's Shanghai composite dropping 1.06%; Hong Kong's Hang Seng index declining 2.38%; Australia's S&P/ASX index giving back 1.64%; and Singapore's Straits Times index plunging 2.9%.
In foreign-exchange trading, meanwhile, the dollar, after years of depreciating against the renminbi, or yuan, rebounded to as much as 6.45 yuan from 6.32 late Tuesday, before closing at 6.38. The dollar had long traded around 6.10 yuan until the announcement by China's central bank early Tuesday that it would abandon fixing the yuan's rate in favor of a system where the last market close and quotes by dealers based on demand and supply changes for major currencies' exchange rates would determine the currency's opening rate.
The move raised the prospect that China's leaders, facing an accelerating slowdown of the country's economy, might devalue the yuan to revive China's export-driven economic growth, a move that could prompt competitive devaluations from other export-dependent countries in the region.
In a report Tuesday titled, “Will China Join the Currency War?,” Chi Lo, senior economist with BNP Paribas Investment Partners, said while such a development isn't his firm's base case, renminbi devaluation presents “tail risks,” and game theory suggests rational governments can make decisions where all players come out worse off.
Many investors say they're relatively sanguine. The announcement on Tuesday should be seen as an important step toward liberalization, in line with what the International Monetary Fund has called for, and not as a competitive devaluation, said Adam McCabe, Singapore-based head of Asian fixed income with Aberdeen Asset Management Asia Ltd., in an email.
Arthur Lau, Hong Kong-based co-head of emerging market fixed income and head of Asia ex-Japan fixed income with PineBridge Investments, said even though China's leadership is showing real signs of concern about the country's slowing growth, there's no reason to believe they're looking to engineer a big economic boost by devaluing the yuan.
Such a devaluation could delay the shift underway now from export-led growth to an economy more dependent on domestic consumption, said Mr. Lau, who pointed to the volatility of the past few days as evidence that China's economic policymakers aren't yet as skillful as some of their developed market counterparts in communicating with the markets.
Already, consumption is more than 50% of China's gross domestic product and growing, lessening dependence on exports to provide growth, agreed Sean Chang, head of Asian debt investment with Baring Asset Management (Hong Kong). Meanwhile, even as the renminbi was appreciating, China was able to post its largest trade surpluses ever in 2014, he noted.
Meanwhile, the country continues to run huge trade and current account surpluses, factors that should ultimately support further appreciation for the yuan, he said.
On its website Tuesday, the People's Bank of China cited similar factors in contending that there's no reason to anticipate a dramatic fall in the yuan's value. Meanwhile, the renminbi's rebound from intraday lows Tuesday came amid a news report that the central bank had intervened to support the currency.
Some analysts said the yuan has room to devalue following a long stretch of appreciating against the dollar when other currencies, including the yen and the euro, were rapidly losing ground.
In an interview Tuesday, Chia Woon Khien, a Singapore-based senior portfolio manager, Asian fixed income, with Nikko Asset Management, said her models suggest the yuan was anywhere from 5% to 10% overvalued against the dollar.
Al Clark, Sydney-based global head of multiasset with Nikko Asset Management, said China's move may boost short-term risks in the region but longer term a free-floating renminbi should be “unequivocally positive” for the global economy.
Meanwhile, the volatility of the past few days has prompted some adjustments to the firm's multiasset portfolios, such as increasing underweight positions in currencies that could be impacted, like the Korean won, said Mr. Clark. Likewise, some of Nikko's overweight positions in North Asian equity markets have been trimmed back to neutral weightings, he said.
Nikko's Ms. Chia said the biggest near-term impact of the move by China's central bank could be on its U.S. counterpart, giving it another factor to take into consideration before moving ahead with an interest rate hike.
