SHANGHAI (Reuters) - China's yuan fell sharply for a second day on Wednesday, after the central bank startled markets the day before by revising the way it calculates its guidance rate to better reflect market forces.
The yuan hit a four-year low, with the central bank following through on a statement on Tuesday in which it said it would make the midpoint adhere more closely to the closing quote.
The People's Bank of China set the midpoint at 6.3306 per dollar prior to market open, weaker than the previous fix at 6.2298, but close to Tuesday's closing rate of 6.3231.
The spot market opened at 6.4300 per dollar and was changing hands at 6.4265 by midday, 1,034 pips away from the previous close and 1.51 percent away from the midpoint.
The International Monetary Fund (IMF) welcomed the decision to make the midpoint - an official guidance rate that serves as the center of a 4 percent daily trading band - more reflective of supply and demand instead of policy goals, seen as a key condition for including the yuan in the IMF's basket of reserve currencies.
The United States, however, said it was too soon to judge the implications of China's yuan devaluation.
The spot market took advantage of the fresh downside trading range on Wednesday to depreciate even further.
"Such a surprising move by the central bank, without any previous warning, have caused some panic in the market," said a senior currency trader at a foreign bank in Shanghai.
In a statement on Wednesday before the market open, the PBOC appeared to attempt to reassure anxious investors that this did not mark the beginning of a free fall.
"Looking at the international and domestic economic situation, currently there is no basis for a sustained depreciation trend for the yuan," the central bank said.
Offshore markets have not celebrated the news. Offshore yuan was trading 1.15 percent weaker than onshore spot at 6.5015 per dollar. The offshore market is not bound by the midpoint and is free to bet on further declines in advance of onshore trade.
Overseas stock markets also reacted negatively, with some concerned that a softening yuan will further dent Chinese consumer appetite for foreign products. Regional currencies also slid, setting off worries of a currency war.
Economists are divided about the reason for the decision, in particular, its timing and the drastic nature of the adjustment.
"I'm baffled," said Andy Rothman, investment strategist at Matthews Asia. Rothman discounted suggestions that the move was targeted at supporting exports, or fending off imported deflation. He also discounted suggestions that this was positioning China for the SDR, saying it was not so important a policy goal as to warrant such a drastic change.
The move could be a genuine attempt to reform the currency market, he said, but questioned whether Beijing would have the courage to stand aside if the sell-off accelerates.
Some traders believed the sell-off would be halted once the currency has lost 5 percent.
"Once the yuan's market value gets near to the official midpoint, the one-time devaluation will be over," said another trader at a Chinese commercial bank in Shanghai.
"Judging from the past two days, the one-time devaluation engineered by the central bank could be between 4-5 percent before the currency returns to fresh stability."
Reporting by Pete Sweeney; Editing by Jacqueline Wong