Opinion | The Yuan’s devaluation has made investors nervous | Mint
Active Stocks
Thu Feb 22 2024 15:29:56
  1. Bharti Airtel share price
  2. 1,134.50 -0.46%
  1. Tata Steel share price
  2. 145.85 1.39%
  1. State Bank Of India share price
  2. 765.95 -0.73%
  1. HDFC Bank share price
  2. 1,419.80 -1.28%
  1. Power Grid Corporation Of India share price
  2. 282.55 0.86%
Business News/ Opinion / Views/  Opinion | The Yuan’s devaluation has made investors nervous

Opinion | The Yuan’s devaluation has made investors nervous

With a trade war between the US and China already having ruptured the Kissinger order of stability in Asia, Beijing’s cheapening of the yuan has stoked fears of a ‘currency war’

 (Photo: Reuters)Premium
(Photo: Reuters)

Earlier this week, the Chinese yuan broke the seven-to-one parity against the dollar for the first time since 2008. The People’s Bank of China, which had maintained this level consistently till now, deliberately moved to devalue the Chinese currency after the latest tariff threats issued by US President Donald Trump. The act marks a shift of focus in the current trade tensions between the US and China away from what was seen as a “tariff war" to a potential “currency war". And this spells greater risks not only for those trading in US and Chinese currencies or their stocks (over 60% of global financial investors), but also for capital flows between emerging markets that tend to peg the value of their own currencies to the dollar. So, how does one interpret the possible economic and political reasons for China’s latest currency move?

Let’s start with the economic aspect. A weaker yuan does have certain benefits. All else being equal, China’s own manufacturing competitiveness, which has otherwise been weakening, is likely to strengthen with yuan-priced goods and services getting cheaper across supply chains in East Asia, parts of Africa, etc. It is likely to widen China’s trade surplus with the US in the immediate short run. It will also help China expand trade margins within its own region, especially with Vietnam, Thailand, Indonesia, etc.

At the same time, the devaluation entails some serious risks. It would be wise to recall how China, around 2015-16, tried something similar by letting the yuan depreciate; it led to a stock market crash in China, and billions of its dollar reserves disappeared in just a few days. That devaluation saw heavy bets made against the currency, leading to a massive capital flight from China, further weakening its external position. While China’s capital account seems more stable at this point, the scale of debt denominated in foreign currencies (accrued under the illusion of a stable dollar and yuan) has increased for global companies and (developing) nations across the world, and may be vulnerable to a currency shock if the “currency war" continues. Yet, one can also say that for a yuan devaluation of less than 2%, there has been an “overreaction" of sorts from most foreign investors, who in recent days switched to the safety of gold or other currencies like yen. To understand this, one perhaps needs to get to the politics of this.

What has significantly changed since the crisis of 2008 (in US) and 2015 (in China) is the form and context of the relationship between the US under Trump and China under Xi Jinping. The breakout of a “currency war" where China’s central bank breaks from its own historically managed parity (of 7:1) and asks state-owned enterprises to stop buying US agricultural goods, and with the US reacting by calling China a “currency manipulator", signals the end of the so-called “Kissinger order" between the world’s two most powerful nations.

That mid-1970s’ term refers to a deal brokered by US’ Henry Kissinger with China. With the end of the Vietnam war and the US rapprochement with China, the “order" was to ensure peace and stability in East Asia, where the US “tolerated" and even “facilitated" the rise of China, while the latter acknowledged US dominance as a military power in the Asia-Pacific. Since then, the region has more or less been peaceful. Now, however, it’s hard to be sure.

The US’ own strategic engagement in Asia has weakened under the Twitter-run foreign policy of Trump, who has openly questioned the “value of US alliances" with Japan and South Korea. Notwithstanding Trump, if one closely observes what is happening within most of East Asia, the internal dynamics between South Korea and Japan, and China and Russia have changed too. Only last week, the Japanese imposed trade restrictions on South Korea. A month ago, China and Russia staged their first joint aerial patrols in the region, causing South Koreans to react militarily.

Therefore, with a breakdown of bigger power structures, what the China-US friction has done is offer significant economic and political leverage to smaller emerging nations like Vietnam and Indonesia within their respective regional spaces. In fact, US businesses have been moving most of their manufacturing units to spaces within Vietnam, Mauritius and the Philippines to save on high tariff costs that affect production.

Still, from Taipei to Tokyo or Hanoi to Canberra, China’s own behaviour under Xi has caused anxiety. And if China and Russia continue to converge their political and economic behaviour in the rest of Asia, that may get amplified. While the Kissinger order did not resolve the historical disputes within the region, it allowed stability in Asia for over 40 years. The political ramifications of its breakdown are now making geo-economic conditions more and more fragile in a deeply inter-connected world.

China’s weakening of its currency to hurt US economic interests for political gains will only make other Asian countries more vulnerable to a political crisis that could quickly escalate to a financial crisis—induced by either a dollar currency crash or waves of capital flight. Any markets responding cautiously to the latest devaluation are correct in issuing a “fragile" alert for investors for now.

Deepanshu Mohan is associate professor of economics at O.P Jindal Global University

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Check all the latest action on Budget 2024 here. Download The Mint News App to get Daily Market Updates.
More Less
Published: 08 Aug 2019, 11:18 PM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App