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Posted by: Deepa Vasudevan on Thu, Aug 13th, 2015

China Devalues the Renminbi. Why should all Currencies Fall?

The Chinese currency, the Renminbi, is informally pegged to the US dollar. The Renminbi is allowed to move in a 2% band around the daily rate fixed by the People’s Bank of China (PBoC). On August 11, the PBoC announced that it was moving towards a more market determined system for calculating its daily fixing rate.p Accordingly, it changed the daily fixing rate to 6.2298 per USD from 6.1162 the day before- a whopping 1.9% devaluation on a single day! On August 12, it devalued by another 1.6%, fixing the rate at 6.3306. And on August 13, the fixing was at 6.4010, a further drop of 1.1%.

 

Pic 1: The Chinese Renminbi Devaluation

The Chinese Renminbi Devaluation

Source: www.investing.com

 

The official reason behind the devaluation is that China wants to align the exchange rate with market forces. Market watchers suspect that the present move aims to stimulate growth by giving Chinese exporters a competitive edge.  Whatever the real reason, the devaluation has caused turmoil in forex markets around the world. Here are three main reasons for the volatility.

 

1. Chinese exports immediately become cheaper, and therefore more competitive. Currencies of countries whose exports compete with Chinese exports dropped drastically. That explains the fall in the Japanese Yen, the Korean Won, Singapore dollar, Taiwanese Dollar and Indian Rupee.

2. Countries that import goods from China can get them cheaper in dollar terms. This has two implications. First, markets of other countries could be flooded with suddenly cheaper Chinese items (this trend is worsened by the fact that China’s own domestic growth is slowing down, and so Chinese producers have to look to other countries for revenues). Second, China could export deflation (via its cheaper goods). The second implication is worrying for Europe in particular, which is struggling to come out of a long period of disinflation.

3. Countries exporting to China are also worried, because the devaluation hints at a fundamental slowdown in growth. China’s huge appetite for commodities, especially metals, is expected to decline. That is why commodity exporters in Latin America, and Australia, saw a drop in currency values (In India, metal stocks lost value for the same reason). In fact, all commodity related currencies, such as the Russian rouble and Canadian dollar were adversely affected.

 

In a nutshell, much of the world is affected directly by the Chinese devaluation. Those that are not directly impacted, are adversely affected by the “risk-off” sentiment, which has sent stock markets into a decline across the globe. The prospect of a US rate hike- even if less likely now- makes the situation worse for emerging economies.

 

China’s devaluation has increased uncertainty in financial markets. Policy makers are scrambling to safeguard their exports and growth prospects.  Vietnam, for instance, has already announced a widening of the trading band for its currency, the dong. India has moved swiftly to impose import duties on steel.  If the Renminbi does not stabilize soon, Asian countries may see a series of competitive devaluations. 

Kannan K V on Fri, Aug 14th, 2015 11:13:21 am

Good article, simple and informative. Thanks

Neeraj Gupta on Thu, Aug 13th, 2015 9:55:05 pm

Short and meaningful

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