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|Chinese Currency Devaluation And The Effects On Global Market by obems: 2:18pm On Sep 22, 2015|
The recent Chinese currency devaluation is in tune with what President Xi Jinping of China envisioned for his country, following its objective to transit its economy from one dependent on exports and outside influence to one that finds more expansion through consumers’ spending and other internal factors.
The ambitious transition, however, exposed China to unforeseen developments like the Great Financial Crisis, moderation of global economic activity in recent years and the competitive monetary policy efforts adopted by other major monetary policy authorities. Major quantitative easing progress adopted by various central banks such as the Federal Reserve System and the Bank of England earlier in the post-2008 slump, the Bank of Japan and the European Central Bank more recently have seen notable spillover effects in exchange rate movement, easy transition with free-floating currencies. Yet, for the Yuan, little depreciation was realized. In fact, despite the Dollar gaining across the board in anticipation of a return to Fed rate hikes, the Yuan was still trading higher when benchmarked to 2012
As a follow up measure, China surprised the world on Tuesday by devaluing its currency, in a move likely to boost Chinese exports and support the country’s flagging economic growth. However, the change to the currency’s value was the most dramatic one-day change in two decades.
The move has served as a litmus test for political leaders, especially in the United States who have long complained that China has left its currency at a lower value to boost its domestic industries. It will be recalled that over the past decade, China has let the value of the currency, known as the yuan or renminbi, rise, but the recent announcement by China’s central bank is sure to raise debate over whether the country is giving an unfair advantage to its businesses.
Stephen Roach, a fellow at Yale University who formerly served as a non-executive chairman for Morgan Stanley in Asia, told Bloomberg that the move raised the “possibility of a new and increasingly destabilizing skirmish in the ever-widening global currency war.”
The Chinese economy had slowed to 7 per cent year-over-year growth in the first quarter, the slowest pace in six years. Exports plummeted 8.3 per cent year-over-year in July, according to a recent data released. However, the Chinese central bank has debunked all assertions on its motive for the devaluation, stressing that its goals were more mundane than spurring exports and growth.
The bank said that the change was a one-time event to allow it to set exchange rates in line with free market practices, which many analysts initially agreed.
Footprint to Africa gathered that like many things in China’s economy, the country’s currency is controlled by a mix of market forces and government decree, as Beijing each day sets a target for the trading of its currency against the U.S. dollar, then allows investors to buy and sell the currency for 2 per cent more or less.
Investors and analysts are of diverse opinion on this development as analysts from Citi said, they expect the central bank to intervene somewhat to avoid a sharp change in the exchange rate, while forecasting that the yuan will gradually depreciate another 4 per cent over the next year from Tuesday.
In this context, the move to make the exchange rate more market-oriented follows what American officials have wanted. U.S. politicians have been pushing for China to adopt a more market-oriented exchange rate for years, with the assumption that China’s currency is undervalued.
The Treasury Department in April commended China’s recent efforts to allow the renminbi to rise but said the currency remained “significantly undervalued.”
All the same not all economists agree that that is the case, and this is why China’s decision could actually be a negative for U.S. economic growth, at least in the short term.
The International Monetary Fund (IMF) said in May that China’s currency was no longer undervalued. Now, market forces could pressure the currency to depreciate rather than appreciate, making Chinese products cheaper compared to American goods.
Analysts noted that China keeps its currency loosely pegged to the U.S. dollar, whose value has surged this year and this has left the Chinese yuan looking relatively overvalued compared to currencies in Japan, the European Union, and Asia.
Goldman Sachs analysts said in a note that they do not think China’s currency change will provide a strong boost to the country’s growth. The change was large for a one-day move, but not that much compared to the continued appreciation of China’s currency over the past year, the analysts said.
After today’s move, the yuan is still about 15 per cent higher than it was a year ago, analysts added. Another school of thought has it that those who believe the currency change will be large enough to affect the economy say it will be of benefit for exporters and heavy industry, but bad news for companies that depend on imported goods.
The move could be tilted to mean increased competition for China’s neighbours. A cheaper yuan would make Chinese goods more competitive with other exporting countries in the region, perhaps prompting them to devalue their currencies.
Meanwhile currencies in Thailand, the Philippines, Malaysia, Indonesia, South Korea, Singapore and Australia were said to have nosedived on Tuesday, as analysts questioned whether the move would spark a race to the bottom in currency wars.
Analysts believe that in the United States, a cheaper yuan could weaken American exports to China, widening the already large trade deficit with China, which also goes to fuel the arguments of American politicians and businesses who claim the yuan is undervalued.
It also might add pressure on the Federal Reserve to delay raising interest rates, as a rate hike would put upward pressure on the dollar and make U.S. exports even less competitive.
Chief Economist at Lombard Street Research, Diana Choyleva, said in an emailed response, that “Efforts to print more currency and spur economic growth in Japan and Europe have already pushed the U.S. dollar to seven-year high against those currencies. Now, with China, Japan and Europe all trying to devalue their currencies and spark growth through exports, the value of the U.S. dollar could raise enough to put breaks on the U.S. recovery.”
Additionally, some analysts argued that the move was not primarily directed at boosting Chinese export competitiveness, as Michal Meidan of China Matters, a London-based consultancy, wrote in a note on Tuesday that weak trade data supported the central bank’s decision “but was not the main driver.”
According to GaveKal Dragonomics, the primary goal was longer-term reforms aimed at internationalizing the Chinese currency.
The IMF recently announced that it would delay a decision until the end of the year on whether the yuan would be included in its special drawing rights, which is a reserve asset that includes the dollar, euro, yen and pound.
The IMF has urged China to merge its government-controlled onshore market with the freely trading offshore market and make its currency more flexible, and Tuesday’s development could be seen as addressing this IMF agenda.
The devaluation has indeed sparked fears of a global “currency war” and accusations that Beijing was unfairly supporting its exporters, but the central bank on Wednesday sought to reassure financial markets that it was not embarking on a steady depreciation.
The People’s Bank of China (PBOC) said, “Looking at the international and domestic economic situation, currently there is no basis for a sustained depreciation trend for the yuan.”
However, sources engaged in the Chinese policy-making process disclosed that powerful voices within government were pushing for the yuan to go still lower, suggesting pressure for an overall devaluation of almost 10 per cent.
Submission of analysts over Tuesday’s yuan devaluation after that of 1994 raises market suspicions that China was embarking on a longer-term depreciation of its exchange rate that would make Chinese exports cheaper.
However, data on Chinese factory activity growth and retail sales on Wednesday underlined sluggish growth in the world’s second-largest economy, while fiscal expenditures jumped 24.1 per cent in July, reflecting Beijing’s efforts to stimulate economic activity.
China’s Ministry of Commerce acknowledged on Wednesday that the depreciation would have a simulative effect on exports, as some Chinese steel producers have already cut export prices in response to the lower yuan.
Economic growth in China has slowed remarkably this year and will hit a 25-year low even if it meets its official 7.0 per cent target. Some economists believe China’s economy is already growing only half as fast as official data shows, or even less.
Analysts at BMI Finance Ltd in Hong Kong downgraded their year-end forecasts for the currency to 6.83, down 10 per cent from pre-devaluation levels.
The currency’s drop puts other Asian economies at a disadvantage also and resulted in Indonesia’s rupiah and Malaysia’s ringgit hitting 17-year lows on Wednesday. The Australian and New Zealand dollars also fell to six-year lows.
Indonesia’s central bank pinned the rupiah’s fall directly on the yuan devaluation and said it would step into the foreign exchange and bond markets to curb instability.
There is considerable debate among pundits about whether a weaker currency will truly help China. Some respite will no doubt be felt for export-centered businesses. Yet, this move does not carry the same weight it did decades ago when the economy was more trade-focused, not the least because the magnitude of the exchange rate adjustment is a fraction of previous efforts’ size.
In other stimulus efforts adopted in 2015, the objective was to deliver funds to certain parties including local governments, banks, home owners, new investors directly. This approach will carry vague knock-on effects down the line. Looking at the USDCNY exchange rate compared to Chinese Gross Domestic Product (GDP). Stocks on major world markets fell again on Wednesday in the wake of the yuan devaluation as exporters to China feared a loss of competitiveness.
An MSCI index of stocks on major world markets lost about 0.5 per cent. Companies with notable exposure to China, including German automaker BMW and U.S. luxury goods maker Coach, lost 3.7 per cent and 4.4 per cent respectively. Investors sought safety in top-rated government bonds, driving yields on German two-year bonds to a record low and pushing U.S. Treasury yields down, with some analysts rising the fear that a long-awaited Federal Reserve interest rate rise may now be delayed.
Trading in money markets showed investors are reducing expectations for a Fed interest rate increase in September due to concerns about global disinflation pressures resulting from China’s moves.
“Volatility is picking up and it’s causing turmoil, it’s pushing bond yields lower and it’s casting more doubt on the Fed,” Axel Merk, president and chief investment officer of Palo Alto, California-based Merk Investments said.
The IMF said China’s move to make the yuan more responsive to market forces appeared to be a welcome step and that Beijing should aim for an effectively floating exchange rate within two to three years.
Indeed, Beijing has been lobbying the IMF to include the yuan in its basket of reserve currencies known as Special Drawing Rights, which it uses to lend to sovereign borrowers, which would enable more international use of the yuan.
“Greater exchange rate flexibility is important for China as it strives to give market forces a decisive role in the economy and is rapidly integrating into global financial markets,” an IMF spokesperson said.
William Dudley, head of the New York Federal Reserve, also said an adjustment to the yuan was probably appropriate if the Chinese economy was weaker than the authorities had expected.
On a trade-weighted basis, China’s yuan has been rising in recent years in part because of its peg to the U.S. dollar. The yuan has gained more than 14 per cent over the last year when factoring in inflation, according to data from the Bank for International Settlements, making its exports less competitive.
However, the devaluation was decried by U.S. lawmakers from both parties on Tuesday as a grab for an unfair export advantage and could set the stage for testy talks when Chinese President Xi Jinping visits Washington D.C. next month, given acrimony over issues ranging from cybersecurity to Beijing’s territorial ambitions in the South China Sea.
A cheaper yuan will help Chinese exports by making them less expensive on overseas markets.
The long-term implications of China’s devaluation are difficult to read because of the complicated system of China’s financial markets and economy. As the world’s second largest economy, however, a failed growth effort would certainly be felt in global activity.
Alternatively, there is another systemic strain that this move will contribute to: a growing competitiveness in monetary policy – some would term this ‘currency wars’. Many Developed World central banks have adopted easing policies that seem more directed to devaluing their local currencies than to specifically manufacture change in local growth or stability factors.
The ECB remarked last year that it believed a EURUSD exchange rate above 1.4000 was an economic problem via deflation pressures. Commodity central banks -RBA, RBNZ and BoC have all noted at one time or other these past few years that their currencies were ‘overvalued’ in a soft effort to encourage devaluation. At one point, the BoJ directly intimated that its large QQE programme was targeting a depreciation of the Yen. They backtracked after the G7 cried foul.
By and large if the global economy is in recession, then devaluation may be insufficient to boost export demand. If growth is strong, then there will be a greater increase in demand. However, in a boom, devaluation is likely to exacerbate inflation.
It depends why the currency is being devalued. If it is due to a loss of competitiveness, then devaluation can help to restore competitiveness and economic growth. If the devaluation is aiming to meet a certain exchange rate target, it may be inappropriate for the economy.
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