By Deena Zaidi
China does things differently
and many times, unexpectedly. The country has been in news for many reasons: surpassing the US economy in 2014, being a part of two banks initiated for infrastructure development in
the Asian region, the recent stock market crash and now, the sudden announcement
of the devaluation of its currency, known as the yuan or
renminbi.
On August 11, 2015, China’s
central bank lowered the value of its domestic currency by changing the way it calculates yuan’s daily fixing against the US dollar. The
fixing of the currency will now be based on yuan’s closing on the previous
session, making it more market-based and more aligned with the market supply
and demand. The intense currency movements by China exhibit that the country
can create sudden fluctuations in global markets to flag its domestic economic
growth. While China might be trying to fix its own domestic growth, it raises
some serious concerns for other countries.
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| Source: Observatory of Economic |
Many are confident that the devaluation of yuan
indicates the growing financial troubles in China, but the Chinese central bank
thinks otherwise. The central bank argues that the change is a one-time event in
order to keep China’s exchange rates in par with the free market practices.
While this may be true, the timing for devaluation couldn’t have been worse. The
news of devaluation comes at a time when many investors were already worried
about the repercussions of the interest rate hike by Fed in September this year,
which could have further made yuan cheaper. The devaluation affects the trading
countries in a large way eventually leading to currency wars that may be unfair
to already suffering economies like those in the
Eurozone. The foreign exchange markets are already showing signs of weakness as
they hit a low point, which has never been witnessed since the Asian financial crisis. European Union has
applauded this move by China calling it a reformatory measure even though it
witnessed a fall in its shipments from China due to China’s economic slowdown
this year.
The currency devaluation by
China has created a stir in the European Stock Markets with major auto and
mining stocks getting adversely affected. Currently, Japan and Europe
are both engaged in quantitative easing (QE) to spur economic growth within
their domestic markets. These countries are already lowering their currencies
to make commodities more affordable in order to expand domestic liquidity. With
the devaluation in addition to the QE, since Germany and Japan are importing 8%
and 10% respectively, to China, the devaluation of yuan will only deteriorate
matters further for them. With a weak domestic currency in China, other
economies that are competitors of Chinese exports could also lower their
currency in order to remain competitive in the trade market. The Chinese goods
in foreign markets will get cheaper and more affordable. Even, foreign
companies that run a joint venture in China may not face much impact as they
may face higher prices only for the components they buy outside China. But
countries that are major importers to China are affected the most since the
Chinese buyers will find foreign goods more expensive after devaluation of
yuan. Even companies that have sales in China could find their profits
shrinking or even worthless when converted in their home currency
One of the biggest impacts of
the devaluation may be on the oil prices. Devaluation of yuan will make many
imported commodities more expensive. The magnitude of this influence may also be
huge since China is one of the world’s largest consumers of commodities. This could lead to a market panic and eventually
competitive devaluation across competitors, aggravating the existing problem.
The unexpected move by
Chinese authorities has been received with strong reactions from many countries
and regulators, particularly the US lawmakers. Chinese authorities might
consider devaluation to be a smart move in order to compete in the global
markets but it also highlights the fact that by ‘controlling’ the value of
domestic currency, a country cannot achieve the benefits of ‘free’ markets and
promote healthy competition across the world.
About the
Author:
Deena Zaidi is the chief writer and owner of
the economic website Financial Keyhole