Renminbi devaluation surprises global economy

What the renminbi devaluation means for institutional investors and the global economy

Stefan Scheurer

The latest move by the People´s Bank of China (PBoC) to devalue the renminbi by almost 2% represents the biggest daily deprecation since.

While a surprise to many investors, the exchange rate reforms are complementary with ongoing capital account liberalization measures. The renminbi exchange rate is likely to become more market-driven and volatility both in onshore and offshore exchange rates will likely increase.

While other Asian emerging markets currencies came under downward pressure following the depreciation in early August, ramifications have been limited, in part because these currencies had already depreciated considerably since early and there were next to no immediate policy shifts in reaction to China’s move – with some exceptions.

Vietnam decided to widen the daily trading band against the US dollar. The State Bank of Vietnam devalued the Dong for the third time in, lowering the currency by 1% and widening the trading band from 2% to 3% (shortly after having widened the band from 1% to 2% in response to China’s move).

Oil-rich Kazakhstan allowed its currency, the tenge, to weaken the most against the dollar since a devaluation in early as a lower oil price, a weaker Rubel and renminbi put more pressure on the Kazakh economy and its balance of payments.

The importance of China’s foreign exchange policy for the global economy is unquestionable. Investors are well advised to remain skeptical as capital outflows persist and emerging market currencies remain under pressure. For example, if the US Federal Reserve raises rates gradually over the next few years, more than $1.3 trillion in emerging market non-financial corporate debt will mature by. Rolling these amounts over will be much more challenging in a more volatile, less-liquid market environment.

WHAT TO DO?

While the PBoC will likely use open market foreign exchange operations to reduce volatilities and avoid capital outflows, double-digit depreciation is unlikely. However, further depreciation of the renminbi versus the dollar is possible within the 2% trading band, given the likelihood of divergent monetary policy between the Fed and rising interest rates on the one hand and the PBoC’s further easing of monetary policy, by means of an interest rate cut and cuts in the Reserve Requirement Ratio.

Meanwhile, research by Li and others in, indicates that a 10% depreciation of the renminbi will lead to approximately a 3% increase in export growth. The International Monetary Fund found it could boost GDP growth by around 0.2-0.4 percentage points. This suggests that for a more meaningfully impact on growth, the currency would need to depreciate by around 20-30%.

Given the International Monetary Fund’s request for a floating exchange rate system in two to three years, a further widening of the renminbi trading band would be the next logical step. However, the Chinese government will likely wait until the new fixing methodology has materialized and market expectations have stabilized.

Ultimately, investors’ perception on the risk premium in Chinese investments will likely change and volatility increase as the renminbi leaves its path of steady appreciation.

Renminbi devaluation surprises global economy

What the renminbi devaluation means for institutional investors and the global economy

Stefan Scheurer

Renminbi devaluation surprises global economy

What the renminbi devaluation means for institutional investors and the global economy

Stefan Scheurer

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