August 17, 2015    3 minute read

China’s Surprise Tactic

   August 17, 2015    3 minute read

China’s Surprise Tactic

On August 11th, The People’s Bank of China (PBoC) surprised the market with a sharp weakening of the renminbi’s (RMB) daily fix against the dollar. The currency’s reference point was cut by the second biggest amount in two decades by China’s central bank, letting the renminbi devalue by 2% against the US dollar.

China currency

 

The USDCNY spot exchange rate shows how much one currency, the USD, is worth in terms of the other, the CNY. On Monday the 10th of August, with one USD you were be able to purchase 6.21410 RMBs. After the PBoC announcement we saw a sharp devaluation of China’s currency, with one USD now being worth as much as 6.43540RMBs the next day. This was a 3.56% devaluation of China’s renminbi. The fall on Tuesday was the biggest one-day drop in the currency’s value since January 1994.

“The People’s Bank of China has orchestrated a clever combination of a move to weaken the renminbi with a shift to a more market-determined exchange rate, blunting foreign criticism of the renminbi devaluation”

Eswar Prasad, Former IMF country head for China

Although this was a shock, the market perhaps did anticipate some sort of move by China to take action to tackle its falling annual GDP growth rate. In 2010, it experienced its highest growth rate since the financial crisis at 11.9%. Since the end of 2010, China has slowly experience declining growth rates and finally in Q1 and Q2 of 2015 GDP growth rate hit 7%, with fear that by the end of the year China’s growth rate could drop below 7%.

The move by PBoC to devalue the renminbi could have multiple outcomes. One outcome could be that there is an increase in business activity in China as exports are now much cheaper. This could eventually see China maintain its growth rate above 7%. On the other hand, investors could interpret this as China’s desperate attempt at one more push to help increase growth. This could perhaps have a negative ramification of causing investors to be wary about China’s actions and progress and leading to them relocating their business out of China, therefore resulting in accelerated fall in growth rate.

However China’s selfish reasons for devaluating its currency have caused ripples effect around the globe, with the FTSE 100 and the miners suffering a downtrend and this could continue as China is the world’s biggest consumer of metals. Therefore a slowdown in the world’s second largest economy could see miners being dragged down, and thus Britain’s benchmark index.

This was certainly a surprise to global markets, and its effects are yet to be absorbed. This may lead even the Fed to push the interest rate hike to December of even at the start of next year.

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