China devalued its currency, lowering the “daily fix” (a guiding rate) by 1.9% on Tuesday 11th August – marking a shift in policy and the biggest devaluation in 20 years. The daily fix is announced by the central bank with trading allowed at +/- 2% from this centre point. Wednesday saw the daily fix lowered by a further 1.6% to 6.3306 against the US$.
Chinese Renminbi to US$: January 2015-August 2015
Source: Oanda
Note: Data refer to the daily average bid rate
Exchange rate flexibility
The move coincides with China’s desire to have the renminbi accepted as a global reserve currency by the IMF – which could allow the currency to challenge the US dollar’s dominance globally and confirm China’s primacy in the global economy. Objections to this inclusion centre around the fact that the currency cannot be freely traded. The change indicates a move to a more liberalised, market-oriented currency as the daily fix will now be linked to the closing rate of the interbank foreign exchange market on the previous day. How this pans out in reality will have to be observed over the coming weeks.
A backdrop of slowing growth
The devaluation also looks likely to be the result of slowing economic growth. It is widely believed to be an attempt to offset a fall in exports – which fell sharply in July by 8.3% year-on-year in US$ terms. Other recent economic releases show equally weak trends – including a 6.0% increase in industrial production in July (over the same period of the previous year) and a deceleration of growth of retail sales and fixed asset investment.
Our baseline forecast for China sees real GDP growth continuing to decelerate to 5.8% in 2019. We see a China hard landing as unlikely, with an 8% probability. However, such a scenario (with a hard landing from Q4 of this year) sees Chinese economic growth falling to just 0.3% in 2016.
Chinese Hard Landing Scenario
Source: Euromonitor International powered by CAMI
Note: Charts show the outcome on China of a hard landing commencing in Q4 2015.
Globally the impact of a Chinese hard landing remains significant with the largest impact being felt within the region.
Economies Most at Risk from a China Slowdown
Source: Euromonitor International powered by CAMI
Note: Data show those countries with the sharpest likely fall in real GDP growth in 2016 stemming from a Chinese hard landing commencing in Q4 2015.
Global ripple effects
The devaluation is already having a far-reaching immediate impact:
- Commodity prices have fallen as investors fear the move is primarily caused by a slowing Chinese economy with China being a huge importer of commodities including the largest metal consumer;
- Global equities – particularly mining companies – have fallen. Stock markets around the world including Australia, the USA and the UK have seen falls;
- Emerging market currencies have also weakened including in Malaysia, Indonesia and Vietnam. As have currencies of commodity exporters globally including Russia and Canada.
Over the longer-term, a substantially weaker renminbi would have other consequences:
- Many large Chinese companies are exposed to dollar-denominated debt, and the devaluation means it is now more expensive to service;
- Chinese exports will become cheaper. With exports of US$1,158 billion in the first half of 2015, China remains the world’s largest exporter;
- Imports to China will be more expensive, with the move therefore causing consternation in the boardrooms of multinationals already battling slowing economic growth in China;
- Fears of a currency war in the region are emerging – when other currencies are devalued in a competitive move in order to improve the attractiveness of their exports. The Vietnamese government has already widened their own trading band to 2%;
- The move could even impact the likelihood of the Fed raising interest rates, as doing so could cause further upward pressure on the dollar thus making US exports more expensive.
Trade Weighted U.S. Dollar Index: Major Currencies January 2015-August 2015
Source: Board of Governors of the Federal Reserve System retrieved from FRED
Note: Daily, Not Seasonally Adjusted. Major currencies index includes the Euro Area, Canada, Japan, United Kingdom, Switzerland, Australia, and Sweden.
Much of the reaction so far is a result of the surprise nature of the change and fears that it could be the beginning of a long-term weakening of the currency. The government has moved to allay these fears by saying that there is no basis for a sustained devaluation of the currency. One thing is clear however and that is the willingness of the government to intervene in the economy to support growth. In this sense a sharp and prolonged fall of the renminbi seems unlikely and a more moderate devaluation more likely. Economic data coming out of China in the coming months will be watched even more closely.