23 August 2019
Devaluing the renminbi would not give China a solution to its current travails and would only bring marginal benefits at best. Photo: Bloomberg
Devaluing the renminbi would not give China a solution to its current travails and would only bring marginal benefits at best. Photo: Bloomberg

Why a weaker renminbi is bad news for most Asian countries

Although periodic weakness in the renminbi will emerge, as driven by market forces especially in the face of a strong US dollar, there are no compelling reasons for China to devalue because such as move will not solve any of China’s economic headaches. After all, devaluation is not the best policy option for Beijing and it will only generate more international backlash.

To see this, consider the following.

Given Beijing’s current policy stance, the renminbi is strengthening along with the US dollar against other major currencies, notably the euro and the yen, which have the largest weights in the renminbi trade-weighted basket after the dollar.

This is not helpful for China when its economy is grappling with wobbly demand and deflationary pressures. Its rising debt burden also becomes harder to service if nominal GDP growth slows.

If the dollar continues to rise, the economic pains will only grow. Thus, the temptation must be to let the renminbi weaken as an escape route. But the issue is not this simple.

Start with the deflationary pressures. There are two reasons why price pressures are falling in China: weak commodity prices and slowing construction.

A weaker renminbi cannot correct either of these. In fact, a significant fall in the exchange rate would only depress local demand further by inflating import costs and prices. This will hardly help spur China’s consumption.

What about exports? Well, they are no longer as important as they used to be. The share of exports in GDP fell by a third over the past decade to 26 percent now. More crucially, net exports have been a drag on China’s GDP growth since 2009.

China exports are more dependent on the strength of overseas demand than exchange rate changes. A weaker renminbi might help some exporters’ profit margins, but it is unlikely to spur a sharp acceleration in shipments amid still lackluster global demand.

Thus, devaluing the renminbi would not give China a solution to its current travails and would only bring marginal benefits at best.

Still, it is worth to play the devil’s advocate and ask what impact a sharp fall in the renminbi’s exchange value would have on Asia. It would not be pleasant.

News headlines would scream that “the currency war has come to Asia”. Expectations would rise that other Asian countries would engineer similar currency devaluation to maintain competitiveness. Asset prices in the region would take a beating and volatility would soar.

As far as the economic impact is concerned, there are two channels that matter: export competition and slowing sales to China.

Economies like Malaysia and Thailand compete more directly with China in third markets. As Chinese goods become cheaper in dollar terms, their exporters’ profit margins will be squeezed.

Korea, Taiwan and Japan, on the other hand, do not compete head-on with China in third markets. Rather, their supply chains are closely integrated with China. This will conceivably offer some of their exporters opportunities to source inputs more cheaply when the renminbi falls.

However, these economies also sell a lot directly to Chinese customers for local consumption. A weaker renminbi would thus hit profits for many of their firms.

Singapore and Hong Kong are different. Here, the main channels are finance and services. A weaker renminbi could raise worries that Chinese mainland borrowers would struggle to repay loans taken out from financial institutions in these cities.

Tourism revenue (around 5 percent of Hong Kong’s GDP might have been driven by Chinese visitors) could also take a hit as overseas shopping trips become more expensive for the mainland Chinese.

There is probably less to worry about Indonesia, India and the Philippines. Indonesia’s key vulnerability lies in commodity prices and a weaker RMB could reduce China’s demand for commodities.

But commodity prices have already slid a long way. This same argument applies to Australia and New Zealand. So the worst may be behind them.

India may have seen soaring trade with China in recent years. But, in reality, that is still a small share of India’s economy. And India buys a lot more from China than it sells. So a cheaper renminbi would actually benefit Indian consumers.

The Philippines is not really competing with China, leaving the economy relatively insulated from the impact of a weaker renminbi.

In a nutshell, a sharp drop in the renminbi still seems unlikely. However, should Beijing change its FX policy stance and join the currency war, it would send ripples far and wide.

Most Asian countries would feel the pain. Hong Kong, Singapore, Taiwan, South Korea, Malaysia and Thailand would be more exposed than their Asian neighbors.

For now, stability seems likely to prevail because it is not in China’s or anyone else’s interest to devalue the renminbi.

Opinions here are of the author’s and do not necessarily reflect BNPP IP’s.

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Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”

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