FXStreet (Delhi) – Marc Chandler, SVP at BBH, suggests that China, the world’s second largest economy is engaged in a multi-faceted transition. Key Quotes “Partly driven by its desires of its political elite, and in part driven by competitive pressures, China is moving up the value-added production chain: it is shifting from manufacturing to services, and investment (debt) to consumption.” “To facilitate this transformation, Chinese officials seem to recognize the need for more flexible prices for money. This necessitated the liberalization of money market rates and greater flexibility of its monetary policy. This in turn requires the loosening of the link between the yuan and the dollar.” “This is wholly desirable and necessary. The divergence theme is not only about Europe and Japan, but China too. The cyclical pressures in China will likely prompt further easing from the People’s Bank of China (PBOC). The close link between the yuan and the dollar injects an unwanted tightening impulse in the rising dollar environment that we anticipate.” “The yuan depreciated by 3.87% against the US dollar in the year through mid-December. A decline of a similar magnitude (4%-5%) in 2016 would not be surprising. It would still likely translate into some appreciation on a trade-weighted basis.” “We suspect without being in a clear uptrend against the dollar (and Hong Kong dollar), the extent of the yuan’s internationalization may slow.” In any event, a country with a large current account surplus would be expected to export its savings. Now China is experiencing capital outflows. That is a significant factor that has changed.” “It may be well and good that China now sees these actions are no longer in its self-interest and ceases. However, and here is where the long-game comes in, China should not use this as a pretence to devalue, and then re-link to the dollar when the greenback’s cycle turns. In the short-run, however, if the yuan appears to be more market driven and the market takes it a bit lower, we do not anticipate loud voices of objections. That said, the election year in the US means that there are greater news cycle risks.” For more information, read our latest forex news.