China’s decision to devalue the yuan Tuesday marked the most significant shift in the country’s foreign-exchange policy since it abandoned a hard peg to the U.S. dollar 10 years ago.

Chinese policy makers have continued to exercise tight control over the yuan. The currency, also known as the renminbi, is allowed to trade 2% in either direction around a central fixed rate, which is set daily by policy makers at the People’s Bank of China. The process of how the central rate was set was relatively opaque.

Now, policy makers will base the fixing rate on how the yuan traded at the close of the previous trading day, ceding more control to market forces.

In a statement, representatives of the People’s Bank of China said they devalued the yuan because they want it to better reflect market forces. But a weaker, more market-oriented yuan will also benefit China’s economy in several ways.

Here’s how:

Exports are weak

China’s exports posted a surprisingly steep decline of 8.3% in July from a year ago, according to trade data released over the weekend. Overall, China’s economic growth has been sluggish. Its economy expanded at a rate of 7.4% in 2014—the slowest level in decades. And, according to official data, it’s on track to log 7% growth this year.

But while investors were disappointed by the magnitude of the decline, it was hardly a surprise.

The currencies of China’s rival exporters—like the Japanese yen USDJPY, -0.09% and the South Korean won USDKRW, +0.00% —have depreciated against the dollar while the yuan has been relatively stable.

Indeed, the Chinese currency has been the second-best performing emerging-market currency against the dollar this year (the Hong Kong dollar has recorded the best performance).

Their relative weakness of their currencies has given China’s rivals an advantage in the export market, as the data shows. By allowing the yuan to weaken, China is helping its exporters regain their competitive edge.

Exports were responsible for 22% of China’s gross domestic product in 2014, according to data from the World Bank. So more-robust export growth can have a large impact on the country’s GDP.

Market pressures

Before the devaluation, the gap between the value of yuan traded offshore and yuan traded onshore was at its widest in six months. The offshore yuan is subject to fewer trading restrictions than its onshore counterpart, so it’s more sensitive to market forces.

By allowing the yuan to depreciate, and by allowing the market to set the next day’s reference rate, Chinese policy makers are effectively allowing the onshore yuan USDCNY, -0.21% to trade more like its offshore counterpart USDCNH, -0.00% .

Chinese policy makers said in a release that one of the reasons for the devaluation, and the decision to allow the market to set the daily fixing rate, was to promote a consistent exchange rate between the onshore and offshore yuan.

China’s FX reserves are dwindling

China’s foreign reserves, which are the largest in the world, have been dwindling for the past year. In July, reserves fell by the equivalent of $43 billion to $3.65 trillion in what was the country’s first-ever monthly report on currency reserves.

Three factors have contributed to this: as the dollar as strengthened, China has expended its reserves to prop up the yuan. More money has left the country recently as policy makers have eased the country’s capital controls. The People’s Bank of China has also spent reserves to prop up the country’s ailing stock market.

China’s central bank has been forced to sell reserves and buy yuan to keep the currency steady vs. the dollar. Allowing the yuan to depreciate will allow the country to hold on to more of its reserves.

The SDR

Chinese policy makers have been lobbying the International Monetary Fund to admit the yuan into its Special Drawing Rights basket.

SDRs are a reserve asset created by the IMF to supplement central bank’s currency reserves. The value of an SDR is based on the currencies in the underlying basket—which currently includes the dollar, yen, euro and pound.

Being admitted to the SDR is tantamount to being labeled a reserve currency—a status China’s leaders covet. But one of the IMF’s criteria for inclusion in the SDR is that a currency be “freely usable,” and IMF officials have called on China to allow the yuan to be subject to market forces.

Some analysts say the move could be a major step toward allowing the currency to trade freely—probably the biggest single step since China abandoned the yuan’s fixed exchange rate to the dollar in 2005, and enhances the possibility the currency will be eventually be included in the SDR.

Others argue that China still has too much sway over the exchange rate and that the move will exacerbate tensions with U.S. officials who have pushed for appreciation of the yuan.