China carried out the biggest devaluation of
the Renminbi in two decades to boost its slowing economy, marking an escalation
of international currency wars, surprising markets and risking a clash with
Washington.
The central bank’s 1.9 per
cent downward move was its biggest one-day change since 1994 and since
China abandoned its tight currency peg for a managed float in 2005. It pushed
the daily fix to Rmb 6.2298 against the dollar, compared with Rmb 6.1162 the day
before. The biggest shift this year had been a 0.16 per cent adjustment.
The move, coming as growth
has flagged and the currency has been under upward pressure from its informal
peg to the rising dollar, is in sharp contrast to policy during previous times
of stress when Beijing resisted pressure to devalue. It should help combat a
big fall in China’s exports fueled by the Renminbi’s relative strength.
It comes as China pushes
for the Renminbi to be accepted as a global reserve currency alongside the
dollar, yen, euro and sterling by the International Monetary Fund, which has
cited greater exchange rate flexibility as a key factor.
The adjustment opened China
up to criticism of adopting a competitive devaluation and is likely to
complicate President Xi Jinping’s September visit to the US, where politicians
have long argued the Renminbi is undervalued.
Government bonds attracted
demand from investors worried about weaker global growth. Copper, a barometer
for global activity fell 4 per cent to a six-year low. Brent crude, the
benchmark oil price, fell almost 3 percent; back below $50 a barrel the day
China devalued its currency.
The People’s Bank of China
said the move was a one-off to reflect changes in the way it calculates the
daily fix — the rate at which the central bank sets the currency every morning
and from which it is allowed to move as much as 2 percentage points in either
direction.
In order to understand the
current situation and effect on the world economy a few points that need to be analyzed:
What is the daily fix?
Each day at 9.15am in
Beijing, the People’s Bank of China (PBOC) sets a midpoint for its tightly
controlled currency. When the market opens 15 minutes later, investors are allowed to trade the currency 2 per cent
either way from this midpoint.
Why did the Chinese government devalue the
currency now?
An obvious
catalyst is the slowing economy. In the first and second quarters, China’s
economy grew at an annual rate of 7 per cent, the slowest pace in six years.
Data realised just before the devaluation showed exports fell 8.3 per
cent year on year in July, far worse than expectations for a 1.5 per cent
decline. A weaker currency should help make Chinese exports competitive.
Is the devaluation as a
result of any external pressure that China is facing?
Before the end of the year,
the International Monetary Fund (IMF) will decide whether to include the
Renminbi in its special drawing rights (SDR), a global reserve asset comprising
the dollar, euro, pound and yen. Inclusion would mean endorsing the Renminbi as
a formal reserve currency.
The IMF conducts a review
of the SDR only once every five years, so the PBOC could be stepping up its
efforts to liberalize the currency as part of its quest to internationalization use
of the Renminbi.
Is this the right step
towards reform for the Chinese market?
It is extremely hard to
judge if this is the move towards market reform, the Renminbi had been under
pressure to weaken for months because of capital outflows, but the PBOC
restrained any depreciation by setting the fix higher and selling foreign
exchange reserves. Today’s one-off depreciation eases some of that pressure.
Economists were optimistic
and some of them called it a revolutionary move but we will not know if China
is truly letting the market have a say in the currency’s value until we have
seen it move in a direction that would not be supportive to its own goals.
The Chinese currency has a
soft peg to the US dollar, which has surged this year and contributed to the
decline in Chinese exports. A weaker Renminbi could support the economy, so
Beijing could simply be allowing the currency to slide and use the talk of
market reform as political cover; otherwise it would be controversial for the
currency to be devalued.
Would the Currency
Devaluation matter outside China and have any impact on rest of the world?
Yes. China is a large consumer of commodities
and if the move is interpreted as a sign of economic weakness, there will be
ripple effects. Every currency in the region weakened against the US dollar;
those of New Zealand, Taiwan, South Korea, Singapore and Australia fell 1 per
cent or more the day the Renminbi was devalued.
Dollar strength could make
the Federal Reserve reluctant to lift interest rates, as that would cause
further upward pressure on the US currency.
What are the risks with
this devaluation?
Investors have been pushing
for the Renminbi to weaken, and if they are allowed to determine where the fix
is, it is possible the currency could depreciate quickly. Investors could see
the Renminbi as a one-way bet and start to position against the currency,
raising the prospect of more substantial Renminbi weakness and more economic
uncertainty.
What next does hold in store as far as the
Chinese currency is concerned?
The question that needs to
be looked at is whether Beijing really does allow the currency to trade more
freely. Last year the PBOC moved to stamp out one-way speculation, when the
Renminbi was continually appreciating, resulting in the currency’s first annual
loss in two decades.
If investors begin to push
the Renminbi lower, Beijing may feel the need to act again. If it does not, neighboring countries that compete for exports may complain.
The US could be in a tough
position. It has asked for reform for years, but if China allows the daily fix
to be determined by market forces and the currency depreciates, hurting US
manufacturers, the US would be in a real spot of bother.
According to conventional
wisdom, wars are easy to start and difficult to end. Similarly Beijing’s
devaluation, the biggest one-day currency move since 1994, represents the
latest skirmish in an emerging battle which, analysts warn, may be hard to
reverse.
The move marks a shift in
China’s policy during times of economic stress. In the late 1990s, the country
was widely credited with containing the destruction from the Asian financial
crisis because it held fast to the Renminbi exchange rate in the midst of
competitive devaluations across the region.
In the global financial
crisis of 2008, Beijing also refused to devalue even as its exports, a driver
of the economy, evaporated overnight.
But now, in the midst of a
pronounced and persistent Chinese economic slowdown and continued appreciation
pressure resulting from the Renminbi’s dirty peg to the soaring US dollar,
China’s leaders have decided to take the plunge.
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The unexpected move
by The People’s Bank of China to weaken the Renminbi by its most in two
decades fueled talk of currency wars, although others interpreted the
intervention as a welcome gesture towards market reform and financial liberalization. The Renminbi fell to its lowest level in nearly three years
after the central bank set the daily fix for the currency 1.9 per cent lower,
the sharpest shift on record.
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China devaluation raises
spectre of currency wars. Beijing’s attempt to deal with a slowdown may have a
spill over effect.
All currency wars are
self-defeating for their combatants. When a country slashes the value of its
currency to boost exports, it inevitably triggers competitive devaluations by
its trading partners, thereby robbing the first mover of its initial advantage.
Thus it is unlikely that China, which in effect devalued the Renminbi by 2 per
cent, was intending to whip up currency skirmishes among its trade partners
into a full-scale war.
China’s position as the
world’s largest trading power ensures that its action will distribute
deflationary pressures throughout its global supply chain, while intensifying
pressure on competitors to seek their own currency depreciations. Such
pressures will only grow if such action signals a sustained trend of weakening.
In its most crucial sense,
the impetus for China’s devaluation, which represented the Renminbi’s biggest
drop since 1993, was self-defense. It is not just that exports have been dismal
so far this year and tumbled again in July by 8.3 per cent. It is also that
China is suffering from a chain reaction of structural economic ills that
threatens to run out of control. As ever, China’s true predicament is obscured
by official statistics. The official gross domestic product growth rate was 7
per cent in the second quarter, but several independent analysts estimate that
in reality it may be closer to 4 per cent.
A similar situation exists
with investment, an important growth driver. Official numbers put fixed asset
investment growth in the first half at 11.4 per cent, but a cleaner measure of
how much companies are investing to boost their productive capacities gross
fixed capital formation is running at an estimated 4 to 5 per cent, from 6.6
per cent in 2014..Allowing for the depreciation of existing plant and
machinery, it is possible that China has already ceased adding to its
productive capacity.
Beijing called it a step
towards financial liberalization but that did little to mask the true nature of
a decision that, at a stroke, reduced the value of the Renminbi by 1.9 per
cent. This was a devaluation a modest one, but still the biggest one-day change
in the value of the currency since China began daily adjustments a decade ago.
The consequences may be profound.
The timing of the
announcement was surprising. Later this year, the International Monetary Fund
board will review the composition of the special drawing right, the IMF’s
accounting unit.
China is keen for the Renminbi to be admitted, and had tried to maintain a stable currency and pursue
financial reforms that the IMF would expect of an SDR member. The decision to
let the Renminbi slide, however, shows that Beijing remains committed to intervention.
A fall in the yuan was undoubtedly what the
authorities intended. They wanted it for two reasons. First, its trade-weighted
value had risen significantly in recent months.
Second, it amounts to a
further easing of monetary policy in the face of sluggish exports, a hiatus in
economic growth, and the sharp depreciation of the currencies of many of
China’s emerging-market competitors.
This intervention follows a
series of policy failures. Beijing’s attempt to bolster the stock market partly
designed to nudge state enterprises away from debt and towards equity
financing, has not worked. There is still serious overcapacity in the
construction sector, and in heavy industries. The weight of debt in local
governments and in non-financial companies is undiminished.
Beijing has been pulling
other levers to try to stimulate the economy. Government controlled
institutions such as the China Development Bank have been allowed to issue
Rmb1tn in new bonds to finance infrastructure projects.
Local government financing
conditions have been relaxed, and the PBC had lowered interest rates and cut
banks’ reserve requirement ratios, allowing them to lend more. In the first
seven months of 2015, new loans were 36 per cent higher than in the same period
a year ago. In short, officials had tried more or less everything they could
short of devaluation.
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As the Renminbi hit a fresh
four-year dollar low, its neighboring currencies came under heavy pressure.
Malaysia’s Ringgit fell 2 per cent to its lowest level since 1998, while
Indonesia’s Rupiah fell a further 1.4 per cent, also a 17-year low. Singapore’s
dollar weakened as much as 0.6 per cent, while Taiwan’s fell 1.1 per cent.
Vietnam was the first
country to take policy action. Authorities widened the Dong’s trading band from
1 per cent to 2 per cent. The dong weakened 1 per cent, with 22,040 dong
required to buy a US dollar.
It is also important to
acknowledge that Beijing’s new policy possess a risk for China on the whole.
The weaker currency
increases the odds of a surge in default of foreign currency debt, which makes
the country highly vulnerable to capital flight. The PBOC is aware that a lower
currency would push others to the brink, which is why that there is a high
probability that they won’t allow the currency to fall much further.
As far as India is
concerned the winners would be mobiles, laptops, toys as they are mainly
imported from China and they will become cheaper further.
The losers would be metal
and steel sector as imports from China would flood the market, new capacities
in steel and other metals that have been commissioned recently may struggle to
compete with the cheaper imports.
Tyres is another sector
that would be hit as Chinese companies are selling tyres almost 20-25% cheaper than the Indian
companies and Chinese imports make up 34% market share in replacement market
for trucks and radial tyres and 45% of passenger car radial segment. With
margins very slim in the textiles currency volatility plays a very important
role and China imported 39% of the total cotton yarn of India worth $ 1.7bn in
FY 15, Indian textile industry faces stiff competition from India.
-Farzan Ghadially
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