• Statement raises speculation PBOC will allow further declines
  • Citigroup recommends selling Korea's won and Taiwan's dollar

China’s efforts to shift the world’s attention away from the yuan-dollar exchange rate to a broader-based index is a sign to traders that the currency’s decline versus the greenback has just begun. A Barclays Plc index with similar components to the new gauge shows just how far the yuan has left to fall.

A unit of the People’s Bank of China announced a new yuan index Friday, composed of 13 currencies, to “help bring about a shift in how the public and the market observe RMB exchange rate movements,” according to a central bank statement. Barclays’s yuan trade-weighted index shows the currency’s depreciation against the dollar this year has been offset by gains versus other trading partners, such as Europe and South Korea, giving scope for the Chinese currency to plunge further.

Before a surprise August devaluation, the yuan had traded closely with the strengthening U.S. dollar, dragging the exchange rate up at a time when China is growing at the slowest pace in 25 years and inflation as measured by the country’s producer-price index has fallen for a record 45 months. Policy makers’ plan to let the depreciation catch up with its trade competitors was already underway ahead of Friday’s announcement. The PBOC cut the daily reference rate by 0.8 percent this week, the most since the Aug. 11 weakening.

Combating Deflation

"Everyone targets a basket of currencies -- no one wants to get out of the line with their neighbors," said David Loevinger, a former China specialist at the U.S. Treasury and now an analyst at fund manager TCW Group Inc. in Los Angeles. “But I don’t think they want a global currency war to gain competitiveness to steal growth from the rest of the world. It’s more about flexibility and combating deflation than trying to spur exports.”

The yuan has slumped 3.9 percent against the dollar this year, compared with a 3.2 percent gain against the won and and a 5.9 percent advance versus the euro.

Friday’s announcement came after the PBOC allowed the decline of the yuan-dollar exchange rate to accelerate this month and the International Monetary Fund said it will add the currency to its reserve basket. The PBOC has reversed a policy where it had spent hundreds of billions of dollars to contain the drop stemming from the August rout.

A basket of currencies “can better capture the competitiveness of a country’s goods and services,” the PBOC said on its website.

Weak Economy

The appreciation was increasingly at odds with a weakening Chinese economy as it hurt exports. By tying to the dollar, it also essentially linked China’s monetary policy to the Federal Reserve’s and limited the central bank’s flexibility to cut interest rates. Futures traders see a 74 percent probability that the Fed next week will raise U.S. interest rates for the first time in almost a decade.

A sustained yuan depreciation threatens to derail analyst calls that emerging-market currencies are set to turn a corner after a three-year, 30 percent selloff. Goldman Sachs Group Inc. said last month they’re bullish on developing-nation assets, with the biggest risk being a “significant depreciation” of the yuan. A stronger dollar and slower growth in China may prompt policy makers to allow the currency to fall with a spillover effect rippling through developing markets, the bank said.

Sell Recommendation

Citigroup Inc., the worlds’ biggest foreign-exchange trader, said investors should sell the won and Taiwan dollar based on China’s close economic ties with the two countries, and the strong exchange-rate correlation they share.

“After the China foreign exchange trade system published weights for a basket today, there is increased speculation about a faster yuan depreciation,” Dirk Willer and Kenneth Lam, strategists at Citigroup, wrote in a report. “The most exposed currencies are the Taiwanese dollar and Korean won, where both fundamental and market links are the strongest. But market links are very widespread and basically extend to almost all Asia currencies.”

To Commerzbank AG, the PBOC’s new tactic is similar to Singapore’s, which employs the currency as its main policy tool, by guiding the exchange-rate band higher or lower against a basket of peers.

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