By BOB DAVIS And LINGLING WEI
BEIJINGâ€"China's central bank is starting to guide the yuan downward against the dollar after two years of trying to boost its value, reflecting concern in Beijing over China's slowing economy and risking a political fight with the U.S.
The People's Bank of China guided the Chinese currency to its weakest level of the year on Wednesday against the U.S. dollar, the third straight day of a push to bring down the yuan's value. Overall, the yuan has fallen 1.1% against the dollar this year after rising 4.7% against the U.S. currency last year.
PBOC didn't respond to requests for comment, and it isn't clear whether the trend will continue in coming days and weeks.
Traders and analysts say the change is aimed at helping exporters cope with slowing sales and reducing the chances of major layoffs ahead of a majorâ€"and sensitiveâ€"once-a-decade Chinese leadership change set to begin later this year. A cheaper yuan makes Chinese goods less expensive in dollar terms.
Chinese Premier Wen Jiabao last week warned that "the task of promoting full employment will be very heavy and we must make greater efforts to achieve it."
The psychological impact of a weakened yuan "will be strong," said Dariusz Kowalczyk, a Crédit Agricole senior economist based in Hong Kong. "It creates an impression that Beijing is so focused on minimizing risks to growth that it is ignoring any U.S. pressure."
But a fall in the yuan is bound to keep it a political issue in the U.S. during an election year in which the Obama administration continues to publicly push China to appreciate. Treasury Undersecretary Lael Brainard said last week that China should "avoid persistent exchange-rate misalignment, and refrain from competitive devaluation," although she credited China with making some progress on the currency front. Republican Presidential challenger Mitt Romney argues that the administration isn't tough enough on China and has said he would name China a "currency violator," a designation that could trigger a confrontation with China over possibility of U.S. trade sanctions.
In conducting trade with America, [China] permits flagrant patent and copyright violations, forestalls American businesses from competing in its market, and manipulates its currency to obtain unfair advantage," Mr. Romney said on Tuesday in a speech to the Veterans of Foreign Wars, according to his prepared remarks.
Meanwhile, on Wednesday the International Monetary Fund reiterated that China's currency is "moderately undervalued" against a basket of currenciesâ€"meaning that the value of the yuan should rise, not fall, over the next three years or so. The IMF didn't specify the degree of undervaluation in its annual assessment of China's economy, but individuals who track the IMF say the yuan is likely to be judged to be undervalued by less than 10%.
China's representative to the IMF, Zhang Tao, said the IMF's characterization of the yuan "is not consistent with the reality." Instead, he said the currency is "roughly in equilibrium"â€"meaning that it didn't have to appreciate much more, if at all.
Beijing has its eyes trained on not just the dollar. The European Union is China's No. 2 export market after the U.S., and the yuan has appreciated 5.7% against the euro since January. During that time, the dollar has risen 6.9% against the euro. By reducing the value of the yuan against the dollar, the PBOC slows the rise of the yuan against the euro.
That provides some help to Chinese exporters who are feeling the effects of Europe's continuing debt crisis. "We've seen a sharp drop in demand from Europe," said Xu Peng, an official at Huihong International Group, a state-owned textiles company, which has started to take out trade insurance to make sure they get paid by their European clients.
The People's Bank of China sets a daily rate, called the parity rate, for the yuan's trade against the dollar in the mainland currency market. The central bank then allows the yuan to move up or down by 1% in daily trading.
Until this week, the PBOC has mostly tried to limit the fall of the yuan by guiding it to be stronger against the U.S. dollar compared with the previous day's close. But on Monday it set the parity rate weaker against the dollar than it was on the previous Friday, according to data provider ChinaScope Financial in Hong Kong. It continued that pattern the following two days.
It is unclear how firm the trend is: This week's action could be followed by a return to the past practice of guiding the yuan higher against the dollar.
As the Chinese economy has weakened, traders since late last year have frequently bid down the value of the yuan, and in recent days they have brought it close to or right at the bottom of the 1% limit. It closed at 6.3885 to the dollar in Asian trading Wednesday.
Part of the reason the yuan is falling is because market forces, rather than government actions, are playing a larger role in determining the value of the currency. That is a development the U.S. has said it wants to see, though the U.S. government clearly wants even further appreciation.
When the yuan was rising strongly, Chinese importers settling their payments preferred to borrowâ€"rather than buyâ€"dollars from banks. Now, lowered expectations for the yuan's appreciation have led many Chinese companies to buy dollars, a development that pushes the yuan down. According to official data, nonfinancial Chinese companies in June registered a net purchase of $14.2 billion of foreign currencies in June, a rate of monthly currency purchase only exceeded once before.
With $3.24 trillion in foreign-exchange reserves, the Chinese government has the wherewithal to sell sufficient dollars to assure the continuing steady rise of the yuan if that were the direction Beijing preferred. But such a move could backfire because it could be interpreted as a signal that money is fleeing China because of poor economic prospects.
"Authorities certainly don't want to signal any weakness," said Brookings Institution China scholar Eswar Prasad. "So they will intervene very cautiously, if at all."
Write to Bob Davis at bob.davis@wsj.com and Lingling Wei at lingling.wei@wsj.com
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