Is The Chinese Currency Drop Spurred By Fear And Envy?
![](https://investmoneyuk.com/wp-content/uploads/2024/04/bernd_dittrich_T4D0DOMJvec_unsplash.jpg)
China’s intention to weaken its currency is likely prodded by a mix of its macroeconomic troubles and rising competition with Japanese exports, according to analysts.
In 2024, so far, the yuan has shed a little over 2% of its against the US dollar, falling to its lowest level since November. This was in reaction to the dollar index strengthening beyond the 106-mark as expectations for interest rate cuts in the US faded.
A dollar now buys around 7.24 yuan, compared with 7.20—a key technical level—just a month ago.
Global risk aversion due to tensions in the Middle East, as well as divergence between the US Federal Reserve and other major central banks, boosted the greenback against a basket of six key currencies, including the Japanese yen.
Apart from historical and linguistic connections between Japan and China, resulting in similar names for their respective currencies, their co-relation holds strategic and economic importance in the global trade landscape.
The weakness in the yuan, which inevitably caused chaos in the Asian currency market, is linked to the yen’s plunge to a 34-year low this week. Yen, the third-most traded currency in the foreign exchange market, has shed 8.6% since January 1.
Looking at this, the People’s Bank of India pegged the yuan’s reference rate at its highest level since March 1, according to Khoon Goh, head of Asia research at ANZ. This indicates that Chinese authorities are allowing the yuan to trade weaker, which makes Chinese products cheaper for the rest of the world and boosts demand.
“In order to drive exports, Chinese authorities will need to keep the yuan stable-to-weak rather than let it strengthen,” Charu Chanana, head of FX strategy at Saxo Markets, said. “Yen weakness is another reason why China cannot let yuan strengthen.”
When the world’s second-largest economy is in peril, it is all the more important for it to deploy all its tools to bolster recovery.
The Twin Currency Matter
China has a currency system that operates on a combination of a controlled onshore yuan and a more freely traded offshore unit. Even as market forces determine the of onshore yuan to a certain extent, the People’s Bank of India publishes a reference rate for the yuan against the dollar every day.
The onshore yuan can rise or fall by a maximum of 2% from the midpoint, commonly known as the fixing rate, in one trading day. The offshore yuan, on the flip side, is free from any restrictions.
Chanana believes that the key driver for China is external demand, while consumption and real estate remain key challenges. Thus, pegging the yuan lower is a strategic policy move that helps governments increase the appeal of their exports in global trade.
To measure China’s export competitiveness with Japan, an exotic currency pair involving offshore yuan and yen is key to watch, Chanana said. Currently, one Chinese-yuan buys 21.32 yen. “A break above 21 is a red flag,” she said, meaning if the Japanese yen depreciates below 21 against the yuan, China loses its edge.
GDP figures released a week ago showed a sharp contraction in China’s exports in March, and an unexpected decline in imports. China has struggled with a prolonged property crisis, high local government debt, and weak private-sector spending. Separately, industrial production and retail sales for March came in weaker than expected, suggesting that more stimulus is needed.
“We believe that the Chinese authorities will still be looking to ease monetary policy … Perhaps the trade-off they are making now is by allowing the currency to adjust. Then, it opens up room for them to move on to monetary policy easing and supporting domestic demand,” Goh said.
On Thursday, China’s central bank cautioned against large-scale monetary easing on signs of a slowdown in bank lending. This signalled that it is unlikely to lower policy rates any time soon, as the priority remains stabilising the yuan.
The plunge in the onshore Chinese yuan this week also had a spillover effect on other Asian currencies. The Indonesian rupiah fell below the key technical level of 16,000 per dollar, registering a 4-year low of 16,312 per dollar. The currencies of other export-oriented economies in Asia, such as the such as the South Korean won and the Taiwan dollar, also fell to multi-year lows.
On Thursday, Bloomberg reported that Japan and South Korea expressed “serious concerns” over weakness in their currencies and warned of taking steps to counter any drastic volatility.
The Onerous “Plus One” Strategy
The escalation of the trade war between the US and China in 2019, disruptions caused by Covid-19 pandemic, and rising labour costs compelled major advanced economies to look at alternative economies to set up shop.
Thailand, Malaysia, and Vietnam are of great appeal to multinational firms as these countries have unutilised infrastructure and production capacity.
“If you have the yen weakening, then it puts pressure on other major exporting currencies to move in tandem to maintain export competitiveness,” Goh said.
India, too, is an attractive investment destination for manufacturing companies to set up units due to cheap labour costs, business-friendly government policies, and research and development.
But India’s exports are not as large as those of other Asian countries, which already have strong manufacturing capabilities. Therefore, India stands to benefit by keeping its currency stable. The more stable a currency is, the more foreign investment flows.
In the last month, the rupee has registered a new all-time low on several days as the global strength of the greenback weighed on emerging market currencies, including the Indian rupee. On Friday, the rupee was Rs 83.55 per dollar at the time of writing, compared to Rs 82.86 a dollar a month ago.
“The rupee may be at a record low against the US dollar, but it is definitely not a weak currency,” Philip Wee, senior currency strategist at DBS Bank Singapore, said.
Source link