China advances exchange rate reform, a credit positive

BEIJING -- China's new forex rate formation mechanism is credit positive as it will increase currency flexibility and support China's capital account liberalization, said Moody's in a recent report.

The People's Bank of China on Tuesday adjusted the exchange rate formation system to close the gap between a lower central parity rate and market expectations.

The market reacted with surprise and the falling yuan led to a heavy sell-off, declines in Asian stocks and falls bulk commodity prices, as well as claims that the depreciation was engineered to support exports.

"The most significant credit implication of this policy shift is that it constitutes progress along the path towards capital account liberalization," said Moody's.

The report noted that there could be further downward pressure this year, but another sharp depreciation is unlikely.

According to Moody's, there are a number of fundamental factors that should support the exchange rate, including a sizable current account surplus, and an estimated $3.7 trillion in official foreign exchange reserves.

Moreover, the Chinese economy's net international assets are equivalent to 17 percent of GDP, and allow it to withstand some amount of exchange rate volatility, said the report.