-Analysis-
BUENOS AIRES — In early August, China’s Central Bank began to change the way it sets exchange rates for the Chinese currency, from one based on estimates of forex supply and demand to one that also factors in interbank market transactions and other currency rates. The authorities said the change led “market forces” to cause a slide in the RMB, or yuan.
After several years of rate stability between the U.S. dollar and the RMB, the Chinese currency has fallen to lowest level against the dollar since 2011. Even as signs point to a possible implosion of China’s economy, Chinese authorities have explained that the currency devaluation was meant in part to satisfy the International Monetary Fund’s demands that China take greater account of currency market laws.
In November, the IMF is set to make its five-year revision of the basket of currencies making up its Special Drawing Rights (SDR) fund. China wants to make RMB a convertible currency and included in the SDR basket. The IMF argues it doesn’t qualify yet since the state, and not the market, continues to determine RMB value. But it did express satisfaction at the Central Bank’s alteration of exchange criteria, which has improved RMB’s chances of entering the SDR basket.
But as we continue to see, the markets have not been kind, and the devaluation caused concern — if not outright panic. It’s hard to contemplate a central bank using an abrupt devaluation as a means of enhancing the prestige and solidity of its currency.
The commercial explanation
Another view of the devaluation is that the Chinese government wants to stimulate exports and related economic activities. Chinese exports have shown signs of weakness in recent months (falling 8% in July year-on-year, twice as much as authorities had anticipated), and that affects economic growth.
Despite faltering exports, China still has a strong trade surplus, though its current account (including exports and imports of services) has passed from positive to neutral and even a slight deficit, because an increase in service costs especially in tourism.
Its capital account also hovers between negative and neutral, as capital going out through the foreign investments of Chinese companies now exceeds incoming foreign investments.
The Chinese Central Bank has so far reacted by supplying Chinese people and companies with liquidity, of which it has vast reserves. Devaluation will reduce demand for currencies while boosting their inflow through exports.
Regarding the economy, the Central Bank puts China’s growth rate at an annual 7%, close to government objectives and to levels needed to sustain employment and social stability, which underpin the legitimacy of China’s authoritarian government.
We should recall that Chinese stock markets — particularly the Shanghai stock market, one of the world’s biggest — are tanking, with the sudden popping of a speculative stock bubble fueled this year by Chinese authorities themselves.
The market drop in China, the world’s No. 2 economy, has prompted concerns about its impact around the world, since the previous stock inflation was financed by debt among private investors and losses can affect their solvency and market confidence more generally.
All this is happening as the financial sector’s internal debts have reached 200% of GDP, double the rate of developed countries, and amid some skepticism on the solidity of the Chinese financial system and the government’s ability to face these kinds of problems.
Exports paradox
The paradox in wanting to boost exports through devaluation is that just two years ago, the Chinese government laid out plans to move away from growth that’s based primarily on exports and investment and more toward growth sustained by domestic consumption and investments abroad, which have grown.
Devaluation on the part of the world’s premier exporter (China) may boost exports, but it could also cripple the purchasing power of China’s customers. Indeed, the effects of devaluation on trade have yet to be determined — especially if they create counter-devaluations that will in turn affect international demand.
Labor costs
RMB devaluation will cut the cost of Chinese labor compared with competitors (Taiwan, Japan, United States or South Korea).
It will also discourage Chinese capitalists from moving operations or manufacturing to other Asian countries with cheaper labor like Vietnam and Myanmar, and possibly even further afield given the rising labor costs of recent years.
RMB internationalization
The devaluation can also affect the course of RMB’s more long-term ambitions of international integration. In recent years China had promoted the international use of its money by various means, including trade. Currently 22% of China’s external trade is undertaken in RMB, and the percentage is greater in trade with Asian partners.
Another means was swap agreements between its central bank and those of other states. In 2013, it also opened up pilot free zones in Shanghai and other cities wherein local and foreign firms are permitted to pay specific transactions in RMB, within increasingly higher limits.
The government has also allowed trading in RMB in some markets including London. These channels effectively doubled RMB presence in world markets last year. Yet payments in RMB constitute just 2% of all payments, which is far from the amounts of payments made in dollars, euros or yen.
Commodity impact
Raw materials are one sector RMB devaluation has hit hardest. The market was already faltering for weakened demand in China and amid the very weak recovery seen in the industrialized economies that constitute the main segment of global demand.
RMB devaluation will thus impact commodities exporters, like Argentina, while favoring its customers — like China.
But it could harm China’s own investment projects, which are mostly, directly or indirectly, linked to the extraction and transportation of raw materials back to China: oil in Argentina and Venezuela, minerals in Peru and Brazil, or building railways in Brazil and Argentina.
