Over the past weeks, China has devalued the yuan twice in a move that has sent ripples to as far as Turkey. Countries dependent on China are fearful that this would create another Asian financial crisis, like what took place in 1994.
The devaluation of the yuan comes on a top of a slowdown of Asia’s and the worlds’ second-biggest economy and commodity creator. It is hurting several nations from Australia to Brazil, South Africa and Malaysia. It is also threatening a lot of vulnerable emergent economies like the case in Kazakhstan, wherein the currency went down 20 percent against the dollar. Kazakhstan is still trying to regain control of its exchange rate. Meanwhile, Vietnam devalue the dong while the South African rand and Turkish lira are experiencing extended losses.
Chinese companies will have to pay more yuan just as the US Federal Reserve is prepping to increase its interest rate too. As a result, they are now threatened to displace Asian exports and other emergent market competitors.
What are the triggers?
China has about $1 trillion debt from dollar-denominated banks. Now that the yuan is weaker, it will add to the debt burden for already pressured Chinese companies. Also, regional economies dependent on China are dwindling, especially in the face of US tension. Remember that in the mid-1990s the US was main buyer of Chinese products.
So when the exports sagged, and mind you, it’s really low with a minus 8.3 percent year-on-year last July, the rest of China-dependent Asia becomes seriously affected.
According to Bank of America, the yuan is expected to become weaker until the end of 2016. It will fall close to a 10 percent depreciation, which will create a 5-20 percent move in the rest of Asia and some countries in Europe too.
“It’s a one-time change.”
Chinese authorities insist that the devaluation would drive the yuan toward more market-driven trends. The move is a directly triggered by the government’s worry over the slow economic growth. If the yuan is devalued then that would flag exports when other efforts to boost the economy have failed.
The dip in the yuan, Chinese authorities further explain, is merely a move to make the midpoint more market-based as it has diverged quite a bit for a long time now. After all, for decades, China has set a midpoint for the value of the yuan as pegged against the US dollar. Daily, it is allowed to move 2% below or above that midpoint. However, the Chinese central bank would sometimes ignore the daily moves and would set the yuan stronger against the dollar a day after an otherwise forecast.
Therefore, what the Chinese central bank merely did was a combination strategy of weakening the yuan while shifting to a more exchange rate that is market-determined.
The devaluation of the yuan might also cause political ripples around the world. It might reignite criticisms within the US Congress and American companies over China’s control over the yuan’s exchange rate. At present, the currency is already very weak so sales of Chinese goods are cheap on world markets.
Also, China is trying to let the market decide the bigger role for the yuan’s value. This is another plot to pressure the IMF into declaring the yuan as an official reserve currency like the dollar, euro, British pound and Japanese yen, given the ripples the devaluation is creating to different economies around the world. When it’s allowed to become an official reserve currency, then China’s influence would only increase.
The devaluation will also rankle Washington policymakers as they are likely to see it as a form of Chinese commitment to limit intervention. It must be recalled that after high-level talks between Chinese and US officials in June, China agreed to intervene in the foreign-exchange markets but only when it’s necessary. By that, it means disorderly market conditions, and other measures that will help transition to an exchange rate that is market-oriented.
The real proof here of whether the move is about reform or growth will be realized whether or not China will be able to pull off its shift to an economy-oriented and domestic demand, and away from export-led trend.