Global financial markets were thrown into panic as China allowed the Yuan to devalue for three days in a row in an effort to combat the countries slowing economic growth.
The annual increase of China’s economy has slowed from a staggering 10% to around 7% annually, and even though this figure is still massive compared to almost all other countries, (The United Kingdom’s economy grew by only 2.4% in 2014) many economic analysts have predicted this inevitable slowing down to be the beginning of China’s moribund.
Senior officials at China’s Ministry Commerce stated that the devaluation of the yuan “will have some stimulative impact on exports”. A weakened currency can be used as a way to combat a slowing rate of economic growth as a devalued currency makes exports cheaper, thus making domestically sourced goods more attractive and competitive in international markets.
The yuan typically does not trade freely within the global market, and in the past it has been artificially manipulated to remain expensive, but as Chinese exports are consistently falling by around 8% annually China has needed to help its exporters to remain competitive. There have also been suspicions that China’s economy is growing at a much slower rate that official reports suggest meaning that China could be on the brink of financial disaster.
The Chinese have also kept no secret in wanting to be apart of the International Monetary Fund reserve assets – known as the “Special Drawing Rights (SDR)” – and this devaluation coincidentally follows the IMF stating that “significant” progress needed to be made before the yuan could be included. As it has been made apparent the inclusion of China within the SDR is some time away, it has removed some of the pressure for China to have absolute financial stability.
The Consequences
With each passing day it becomes increasingly apparent that we live in a globalised world. Almost all countries enjoy the benefits of goods, services and people being able to freely flow across state boundaries. However, we must also consider how the actions of one state can have tremendous repercussions in another. China allowing the yuan to devalue has had a rebound effect on the global economy, causing a tidal wave of consequence specifically in emerging economies.
Currency War
As a consequence of the Chinese yuan devaluing and making goods cheaper on the open market, other emerging markets’ currencies have felt the pressure to depreciate in order to compete for business. Asian economies seemingly have been worst hit with the Indonesian rupiah and Malaysia’s ringgit falling to their lowest level in 17 years.
There are predictions that India will have a very hard time in the future, especially in industries in which it directly competes with China. Textiles and apparels will be hit hard due to Indian products losing their currency competitiveness making exports more expensive than China’s. India has had a difficult time exporting as it is with demand contacting for the past 7 months in a row, not just in apparel but in commodities like chemicals and project exports. If businesses can see that they can source the same product from China for a smaller cost then Indian exports may suffer even more.
Undermining Local Economies
African countries have somewhat recently partaken in an economic boom in recent years and this has been catalysed by Chinese investment. In terms of trade, China is Africa’s biggest partner with the exchange of around $160 billion worth of goods a year. It has made sense for countries like Nigeria to store yuan in its foreign reserves – 5-10% in total – to make buying and selling goods easier as they can readily exchange good for currency. Nigeria specifically gets a good deal from China as Chinese clients selling manufactured goods often pay export taxes which injects foreign money into the economy. Therefore, the local value of the Nigerian naira is dependant on the yuan due to the two currencies working in conjunction within the local economy.
The yuan being cheapened has effectively reduced a large amount of value of Nigeria’s foreign reserves, which is undoubtedly frustrating as it is used instead of the dollar to avoid the fluctuating prices associated with oil. The yuan devaluing has also had an effect on the local economies where it is prominent due to the confusion of fluctuating exchange rates. Many African countries have been burnt by this unfortunate gamble and have lost out because of their decision to invest in yuan. This has undoubtedly created uncertainly and turmoil regarding how viable the yuan is as a reserve currency for the future.
Not All Bad
Even though there may be significant losers in the emerging economies, some are actually benefiting from the devaluation of the yuan. Those who source products from China will now have to spend a little less as they profit from the reduced cost of importing. This is the case for India who has imported $139 billion worth of crude and petroleum products from China in 2015 so far. Every $1 drop in prices equates to a $1 billion drop in the country’s oil import resulting in India saving a significant amount of money. The same can be said for importers of electronic goods in India who frequently bulk buy their components from China, or the importers of $3 billion’s worth of Chinese copper products.
Emerging economies will now bare the scars of China’s actions and for some countries their economies will suffer substantial mid and long-term consequences. The yuan being devalued is only the first symptom of China’s declining economic growth, and if the Chinese are prepared to lose the trust of its biggest world partners in its attempt to increase its economic expansion, then we should all be fearful of what is next to come.
