China's surprise devaluation of the yuan, which signals frantic efforts to keep trade levels up and resuscitate the struggling economy, has raised some concerns as to the timing and form of the move.

(Update: since this article was written yesterday, there has been a further depreciation in the Chinese currency.)

China's central bank triggered surprised reactions across the wealth management industry when it devalued its yuan currency by nearly 2 per cent against the US dollar yesterday, in a self-described market reform step. 

The People’s Bank of China raised the central fixing rate for the CNY/USD by 1.9 per cent to weaken the yuan (or renminbi) and changed its rate-setting policy so that it now takes into account the previous day’s closing spot rate. The resulting depreciation is the currency's largest one-day drop in two decades since China ended its dual-currency system in 1994. And wealth managers were quick to flag concerns that this was not the safest way to generate depreciation. 

The chief investment officer of Pictet Wealth Management Asia, Bhaskar Laxminarayan, called the handling of such a sudden adjustment into question, highlighting further yuan depreciation as a likely knock-on effect, as well as downward pressure on other regional currencies. The South Korean won, Australian dollar and Singapore dollar are down approximately 1 per cent amid speculation policymakers will seek to keep their exports competitive.

“I see this as a continuation of the weak Asian currency trend rather than a game changer for Chinese growth,” said Trevor Greetham, head of multi asset at Royal London Asset Management.

“The shock 50 per cent devaluation in 1994 was one of the contributory factors to the deflationary Asia crisis later that decade. This change is tiny in comparison but the central bank will give the market a greater role in setting daily exchange movements and that could mean a more prolonged trend of Asian currency weakness as China’s close trading partners adjust their exchange rates downwards," he said.

The move, which the central bank described as a step towards greater market forces, signals major efforts to boost the world's second largest economy's export performance, which came under the spotlight last week following the release of some disappointing trade data. Chinese exports tumbled 8.3 per cent over July, while producer price deflation drove wholesale prices down to their lowest point since 2009.

The mainland China stock market has, over the year to 7 August, generated total returns (adding capital growth to reinvested dividends) of 54.7 per cent, according to the MSCI China A 50. That index is down 17.5 per cent over the latest three months.

Wealth managers however have cast doubt on how much a weaker yuan will actually help the struggling economy, suggesting that this dramatic devaluation contradicts China's desire to rebalance its economy away from exports and is more to do with fears of an even stronger dollar following a potential rate hike from the US Federal Reserve. On a trade-weighted basis the yuan has risen by around 13 per cent in the past year.

“Central bank policy divergence between the Federal Reserve on the one hand and the ECB and Bank of Japan on the other, has made China’s upwardly crawling peg versus the US dollar increasingly inappropriate. China exports to and competes with the whole world and its currency is up by a crippling 60 per cent against the Japanese yen and a near 20 per cent versus the euro over the last three years,” said Greetham.

“With speculation mounting over a possible September Fed rate hike and domestic data coming in weak, China needed to de-peg and urgently so," he said.

The timing of the depreciation appears to fit into the longer term strategy of the internationalisation of the yuan, specifically Chinese authorities' aim to include the currency in the International Monetary Fund's Special Drawing Rights basket. However, it defies broad expectations that the PBoC would want to keep the currency stable ahead of the IMF's decision.

“While capital outflow pressure has eased recently, our estimate suggests that outflows have nevertheless continued until June with smaller magnitudes. Against this backdrop, we thought the PBoC would be cautious with its FX policy to avoid giving markets the perception of currency devaluation, which would trigger even larger capital outflows,” said Aidan Yao, senior emerging market economist at AXA Investment Managers.

“A 'safer' way to generate depreciation, in our view, was to widen the CNY trading band, which, given the prevailing bearish sentiment, could push the spot rate to the new maximum limit. We acknowledge the statement from the PBoC that [yesterday’s move] is a one-off adjustment, but still think further band-widening is possible in the future," Yao said.

What came as an ever bigger surprise to wealth managers was the change to the renminbi daily-fixing mechanism, which will now account for market views. In stark contrast to the previous mechanism where the PBoC acted as the sole decision-maker on daily fixing, market makers will now be required to submit fixing quotes to the central bank with reference to the previous day’s spot closing price, in conjunction with supply and demand for the currency and major FX market trends.

“If followed through, this could represent a major shift in China’s FX regime, although we are cautious with our interpretation for now, given the lack of operating detail,” said Yao, adding: “Nevertheless, we think this move – to improve the transparency and market influence in the FX formulation mechanism – should increase the RMB’s chance of inclusion in the SDR.”

The fixing will also be determined by the exchange rate movements of major currencies, which implies a move away from a pure dollar peg to a basket of currencies, notes Schroders' emerging markets economist, Craig Botham. 

“If this is so, and the PBoC wants to peg the yuan in trade-weighted terms, depreciation versus the dollar becomes more likely, particularly if the wave of dollar strength continues. However, we believe financial and social stability remain the overriding concerns of policymakers, and so a large devaluation is not on the horizon,” Botham said.