China’s central bank has recently devalued its currency by over 2% against the US dollar. By depreciating the Chinese Yuan, it created great concerns for the domestic and international markets.
So what prompted the People’s Bank of China (PBoC) to devalue China’s currency? Some sources say that after the economy’s dismal performance during the year, this action was aimed at stimulating growth in China’s export sector along with its stock market which had plunged by up to 32% in recent months. The strength of the currency placed great pressure on exporters and had most likely affected output and employment.
Another possible reason is the Chinese government’s desire to have the Yuan steadily rise against trade-weighted partners and to keep the yuan’s appreciation gradual. This was due to the rapid rise of the U.S. dollar in conjunction with China’s aim of managing the exchange rate within a range against the dollar. As explained by Jonathan Anderson at Emerging Advisors Group, this move was not the same as “competitive devaluation” of the Renminbi (RMB), exports would only gain a significant boost if the yuan was devalued by around 20%.
The official reason stated by the PBoC for the devaluation was to make the country’s financial system more market-oriented, and that market spot prices would determine its daily position. This move was to be a “once –off” adoption of a market-based approach to setting the yuan’s value.
Analysts predict that the value of the renminbi will continue to drop, possibly depreciating to a point where the dollar is able to be exchanged for 6.95 Yuan.
Domestic impact, influences (Strength and weakness of situation, benefits and cost)
The devaluation of the yuan has taken domestic markets by storm. Examples of such include the equity and the real estate market. However, by pushing down the yuan, the government is able to stimulate economic recovery along with being able to adjust market structures.
Due to the Chinese governments’ strict control, it is difficult for property developers to access funds from banks. According to the China Index Academy, loans from banks only accounted for 17.4% of housing development funding in 2014 with most property developers accessing capital by issuing bonds in either Hong Kong or overseas markets. Therefore, the yuan’s drop leads to a higher cost for loans which puts upward pressure on the real estate market.
A lower yuan also means a higher dollar, leading to contrasting results in China’s import and export sector. For example, the import industry would decline due to the depreciation of the Chinese Yuan as foreign products become relatively more expensive to domestic consumers, with all else being equal, whereas the export industry would become better off as Chinese exports become more attractive due to their relatively lower price, especially exporters in the textiles industry.
However the depreciation of the RMB may still have positive impacts on the import sector. It may help solve industry overcapacity problems. This is because the high cost lessens arbitrage opportunities between the domestic market and import market, meaning customers turn back to domestic suppliers.
The depreciation of RMB—international impacts
Since the beginning of 2014, the issue of RMB-dominated sovereign bonds in UK and currency swap agreements between China, Russia, Canada and other nations has made the internationalization of the Chinese yuan very fruitful. The Chinese yuan now plays a greater role in global trade settlement. However, the recent depreciation may hinder some of that progress. The depreciation of RMB may also have large impacts on various industries in many economies. Since China is the world’s biggest consumer of goods and services, the slowdown in its economy would very likely drag down the mining industry.
Retailers with a large exposure to the Chinese market were also affected by the devaluation. Burberry, whose 65 stores in mainland China accounts for 14% of the company’s sales, had its shares tumble by 4.4% on Tuesday.
The depreciation of RMB also places pressure on many different economies which export to China, as the demand for their product from Chinese consumers would decrease due to the relative increase in the cost of their products, at least in a short term. Furthermore, changes in exchange rates and export growth would also impact on inflation rates of other economies that are active traders with China. According to Michael Saunders, chief UK economist at Citi, ‘a weaker yuan will still keep UK inflation lower for longer.’
However, the depreciation of the RMB also signals China’s transition to a more sustainable economy. Businesses and foreign exporters or companies may now see new opportunities to export their products to China in long term. Andrew Sentance, a former Bank of England rate-setter, has argued that service and high value-added manufacturing goods could be in high demand among China’s increasingly affluent consumers in the future.
Is the depreciation of the Chinese RMB leading to another Currency War?
Jim Rickards, an American Lawyer, based on the historic Currency wars stated that ‘Currency wars are economic battles that do not produce the results that they are expected to create, which are increased exports, jobs and growth’. Rather it results in extreme deflation, extreme inflation, recession, depression or economic catastrophes. Through his book, Currency Wars: The making of the next Global Crises, he has predicted a full blown currency war which could bring even more severe economic turmoil than the results caused by the burst of the housing bubble in the U.S.. Now the concern is whether China’s attempt of devaluing its currency to boost their domestic exports invites the potential for a global financial turmoil to which the world’s economy is not prepared for.
This surprise devaluation of yuan has already affected various Asian currencies, says Business Day. Indonesia’s rupiah and Malaysia’s ringgit hit 17-year lows, and as a result, Indonesia’s central bank took action, stepping into the foreign exchange and bond markets to curb volatility. The same had been confirmed by the State Bank of Vietnam. Furthermore the South Korean Won, the New Taiwan Dollar and the Singapore dollar are the most vulnerable to a decline in the yuan as their exporters have the highest exposure to the Chinese market of all the Asian countries, according to Barclays, Standard Chartered and Mizuho Bank. In addition, the Australian and New Zealand dollars also fell to six-year lows. “The market was caught off-guard by China’s move,” said Khoon Goh, a Singapore-based senior foreign-exchange strategist at ANZ. “We’re going to see ongoing volatility in the near term as the market tries to digest what happened” he added.
Regarding the depreciation of the RMB, whether this move by the PBoC will achieve its desired overall effect is still in the open. This action has influenced and turned both the domestic and worldwide markets around, benefiting the domestic export industry and those who export to China. Ultimately this is aimed at stabilising the Chinese economy and may act as a catalyst for a more sustainable future.
The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.
