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Tuesday, August 11, 2015

China's devaluation and emerging market currencies

 

Update: On Wednesday, China's central bank fixed the "official midpoint" for the yuan down 1.6% to 6.3306 against the dollar. The midpoint is a guiding rate, from which trade can rise or fall 2% during the day.

The Wall Street Journal said that China intervened to prop up the yuan Wednesday, according to people familiar with the matter, just a day after it had let it decline sharply, underscoring the tricky balancing act now facing its central bank: how to keep the country’s currency from free-falling.

The intervention in Wednesday’s final moments of trading came after the yuan had weakened nearly 2% — the maximum allowed in mainland China — to where $1 would buy about 6.45 yuan, its lowest level against the US currency in four years. The yuan fell another 1% on Wednesday, marking the biggest two-day lowering of its rate against the dollar in more than two decades.

Aug 11, 2015:: Emerging markets in recent times have performed poorly against the developed world, with currencies at their weakest since 2003 and some as low as the Asian financial crisis of 1997-98. Shares are under pressure and today, China has launched the latest attack in a growing currency war by devaluing its currency by almost 2% — Robert Peston of the BBC says it is more significant than either the Greek crisis or if the Federal Reserve raised interest rates.

The one-day move, done in a bid to boost failing exports and maybe to bolster the case for the yuan/ renminbi to be an international reserve currency, was the biggest since 1993 and may, analysts warn, be hard to reverse.

“This shows how desperate the government is over the state of the economy,” said Fraser Howie, a China analyst and co-author of Red Capitalism, as reported by the Financial Times. “If they were trying, as the central bank said it was, to bring the exchange rate back into line with market expectations then they have failed miserably as the market is now just expecting further devaluation.”

Last March, Li Keqiang, Chinese premier, told the Financial Times: “We don’t want to see further devaluation of the Chinese currency, because we can’t rely on devaluing our own currency to boost exports.

“We don’t want to see a scenario in which major economies trip over each other to devalue their currencies,” Li continued. “That will lead to a currency war, and if China feels compelled to devalue the RMB in this process, we don’t think this will be something good for the international financial system.”

However, last weekend China reported poor trade statistics for July with a decline in particular in traditional sectors.

The Wall Street Journal reports that China’s appetite for commodities from gold to crude oil is likely to abate in the near term after the country’s surprise decision to devalue its currency, although a weaker yuan could boost steel exports.

As one of the world’s largest buyers of commodities, China’s decision to devalue the yuan Tuesday—effectively lowering the value of exports and increasing the cost of imports for domestic buyers—is likely to deepen price declines among copper, aluminum and other metals. China consumes nearly half of the world’s annual output of metals.

The Economist says Charles Dumas of Lombard Street Research, a consultancy, recently wrote that a Chinese devaluation:

would export the deflationary impact to its trade competitors in the rest of the world. In addition, countries that became notably overvalued, such as the US and UK, could be weakened as cheap imports cut into margins. This is how the current bullish cycle in stock markets could end." 

The Bank for International Settlements calculates real trade-weighted indices for different currencies; as of June, China's index was 126, up from 111 a year earlier and 105 in September 2012. This shift is just a marginal retracement of that gain.

The newspaper says this move looks more like a signal than anything else. In particular, it may be a response to IMF concerns about whether to grant the yuan reserve currency status and inclusion in the special drawing right (SDR) basket. "China would very much like to get that status, partly for prestige reasons and partly to help its financial sector. So a little bit of currency flexibility might help, yet the move is not big enough to really annoy the country's Asian neighbours or the Americans."

The 1.9% devaluation of China’s renminbi is being seen by some as a shot in the currency wars, but James Mackintosh, the FT’s investment editor, disagrees.

John Authers analyses a day when some bad economic news from China made an impact across world markets.

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