April 18, 2017    6 minute read

The Devaluation of China’s Currency

   April 18, 2017    6 minute read

The Devaluation of China’s Currency

The world has seen the stable growth of China’s economy in the last several decades. As the world’s second biggest economy, China now plays an important role in the global economy. The fluctuations of China’s renminbi has attract attention among investors around the world. It’s worth looking at how the devaluation works in its national economy and the global economy.

In January 2016, the biggest fall in renminbi in five months caused mayhem in global markets and sparked fears among foreign investors. The devaluation has continued this year despite some slight fluctuations. The dollar/renminbi exchange rate rose from about 6.55 yuan to the dollar in January 2016 to approximately 6.88 at the end of November 2016.

Source: XE

The Government’s Perspective

The continuous depreciation of the yuan seems partly due to macro control measures from the Chinese government. The People’s Bank of China allowed the moderate depreciation of the yuan, which the government felt could stimulate the economy. The factors that contributed to China’s rise over the last decade are extensive, but undeniably its strong and steady export-led growth have greatly contributed to its economic miracle.

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(Source: World Bank)

There are, of course, strong correlations between GDP growth and exports in China. In 2009, for example, Chinese exports declined, and in the same year, China’s economic growth rate was signifcantly lower compared with previous years. In 2010, the reverse happened.

Another notable point, however, is that China’s export as a percentage of its GDP had generally declined from 2006 expect for some fluctuations, which indicates that China has also explored other ways to boost its economic rather than depending too much on its exports.

How Does GrowthConnect to Renminbi’s Devaluation?

The macroeconomics theory behind it is simple:

  • A lower exchange rate between renminbi and other currencies leads to lower prices of China exports; foreign countries buy more goods made in China.
  • Increased exports pushes up net export (export-import) which is an important component of GDP.

How effectively does it work?  

In 2009, the dollar/yuan exchange rate was only slightly lower than that in 2008, yet 2009 saw a significant decline in the China’s exports. This fact indicates that there are various factors other than the exchange rate can potentially have impacts on the export. The global Financial Crisis of 2007-2008 was one reason: the global economy was still at the stage of recovery in 2009, which reduced the demand for exports from China.

How Could the Government Influence the Exchange Rate?

Normally the government cannot directly control the exchange rate. But the government can always conduct some actions to influence it through changing the demand and supply of renminbi in the international monetary market. A relatively low demand and high supply lowers the exchange rate of Chinese Yuan.

  • Lowering interest rates: With lower interest rates in China, foreign investors tend to invest less in the country as they will get less return from their investment. The decreased demand for renminbi lowers its exchange rate. There are plenty of methods for the central bank to lower commercial interest rates, including lowering the refinance rate, open market operations (OMO), quantitative easing and lower reserve requirements.
  • Reserves and borrowing: through purchasing more dollars or other currencies using renminbi reserves, there will be relatively more supply and less demand of Chinese Yuan in the international currency market, thus a lower exchange rate.
  • Lending: The Chinese government may lend more Chinese Yuan to other countries, as a result, there will be a higher supply of Chinese Yuan and eventually a lower exchange rate.

The Trade-Offs Faced by the Chinese government 

It is impossible that everything goes well, there must be some costs.

  • The less valuable renminbi makes China lose more potential foreign investment. The lack of foreign investment means fewer opportunities of technology development and less employment in the long run.
  • The economy is unstable if it depends too much on exports. International trade is about more than one country – the Chinese government is passive in these two-way trades as the demand of goods made in China greatly depends on the economic conditions and policies in the importing countries. If the governments in the importing begin to introduce tariffs and import quotas, for example, the Chinese economy may suffer shocks, while these political actions are out of the Chinese government’s control.
  • Lower exchange rate of Chinese Yuan is always a bad news for those who are currently studying aboard. The number of international students from China has increased significantly over last decade, and a less valuable renminbi means that students have to pay higher tuition fees and living expenses in foreign countries. However, in a country with a large population like China’s, the students studying abroad is a relatively small group and they are considered rich, so the government may not pay attention to the minority.
  • There will be unclear responsibility distribution. Sweatshops are still a common thing in China, and the cheap labour force is another reason lowering the price of China exports. In some cases, Chinese factories sign contracts with foreign companies. The labour working under unsafe and poor conditions produce the goods that will be sold abroad, and it can be very difficult to divide the legal liability between two parties. In 2013, the collapsed factory building in Bangladesh was considered as the sweatshop of Primark, a major retail group operating stores in the UK and Ireland. Under this circumstance, the issues are beyond mere economics and reach to society as a whole.

Will the Trend Continue?

The dollar/renminbi rate has increased since 2014. The reasons behind this are complicated. The monetary tools conducted by the Chinese government are not always effective at controlling the exchange rate. Political changes worldwide could have massive impacts on exchange rates. Following the Brexit referendum in 2016, the pound/renminbi rate decreased sharply. The American Presidential Election in 2016 has also caused more uncertainties in the exchange rate. It should be kept in mind that the exchange rate is the relative price between currencies: even though the Chinese government manages to use some monetary policies to control it to an extent, changes happen worldwide cannot be predicted after all.

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