New | China's yuan devaluation is part of a wider transition

The People's Bank of China (PBOC) surprised the markets on August 11 by changing its daily fixing mechanism, which led to a 3 per cent plus devaluation of the renminbi against the US dollar.

The fixing has since been based on the previous day's average market closing rate quoted from the China Foreign Exchange Trading System, instead of on the moving average closing rates of the past 10 trading days.

The conventional wisdom for such a move was devaluation, under the guise of foreign exchange reform, to boost exports and, hence, economic growth. This is unlikely.

Firstly, China's economic weakness may not be as dire as many observers think, even though industrial output, electricity consumption, freight volume and demand for raw materials have all grown slower than the 7 per cent gross domestic product growth rate.

If China's growth situation was so dire, why did Beijing wait until now to make the foreign exchange policy shift, and why did it not devalue the renminbi by much more? The fact is that China is making a transition to a new growth model. Expanding demand for services such as health care, education, tourism, entertainment and financial products, is less dependent on expanding industrial output, investment and exports, and less demanding for power consumption, raw materials and freight.

The evidence shows that the predominant factor affecting Chinese export growth is global demand, not the exchange rate. Further, the impact of global demand on Chinese export growth is 20 times bigger than the exchange rate impact.

If devaluation were to give Chinese exports a competitive boost, our estimate shows that the renminbi would have to be devalued against the US dollar on a sustained basis by 20 per cent to 40 per cent, depending on the currency-weight assumptions one uses. This would potentially create an unacceptable global financial shock.