12 November 2019
The renminbi's deep devaluation paved the way for China’s export miracle. Photo: Bloomberg
The renminbi's deep devaluation paved the way for China’s export miracle. Photo: Bloomberg

How RMB depreciation will affect Hong Kong

China’s economy experienced a golden period from 2002 to 2007, when exports expanded at a staggering rate of 30 to 40 percent.

Economic growth hit 8 percent each year, and even set a record high of 11.2 percent in 2007. It’s widely attributed to China’s entry into the World Trade Organization and its demographic dividend. However, the sharp devaluation of the renminbi against euro was largely ignored.

Most Hong Kong investors felt the renminbi was quite steady at 8.3 against the US dollar before the foreign exchange regime was reformed in 2005.

The redback weakened against the euro to 10.8 in late 2007 from 7.1 in early 2002, marking a drop of more than 50 percent.

As a result, the eurozone has become China’s biggest trading partner, and the renminbi’s deep devaluation paved the way for China’s export miracle.

In fact, the growth stories of all emerging economies in East Asia stem from exports. It started in Japan in the 1950s to 1960s, and spread to the “Four Asian Tigers” and other East Asian countries and China.

Every export story kicked off with a weak currency as well as cheap labor and land costs.

And the currency would appreciate after accumulating considerable capital. The Japanese yen, for example, surged to 80 against the US dollar in 1995 from 200 in 1985.

However, currency appreciation has not brought good luck to these countries, but rather the bursting of one bubble after another.

These nations have gone through a long-term deflation. South Korea has taken a one-off correction and engineered a successful economic restructuring. However, Japan has lost 25 years without going anywhere.

A decade ago, the euro was the strongest currency. But the redback was the strongest performer last year. It soared nearly 20 percent against the euro, yen, Malaysian ringgit, Mexican peso and the US dollar.

Meanwhile, the manufacturing sector, a key pillar of China’s economy, suffered badly while exports were also hurt.

It seems there are only two ways left for China. One option is to devalue the renminbi by over 10 percent to boost exports. Another option is to accelerate reform and press ahead with economic restructuring.

On Tuesday China cut the daily reference rate for the renminbi by nearly 2 percent, a sign Beijing recognizes that its currency is overvalued.

Nevertheless, there is little chance the renminbi will fall sharply. Beijing is keen to push its currency into the International Monetary Fund’s Special Drawing Rights basket. Global investors would dump renminbi assets if the currency weakens dramatically next year.

However, a 3 to 5 percent drop in the renminbi will help a little in boosting China’s exports, inflation and overall economic growth.

Investors should avoid export plays, like shipping, raw materials and industrials. Utilities and power companies are more attractive with steady returns.

The book, The Dollar Trap, has noted that the Japanese yen and the euro have lost in trying to challenge the dominance of the US dollar. Investors flee to the greenback every time there is an economic or political crisis.

Beijing should not rush in internationalizing its currency. Even the US dollar took 50 years to topped the sterling as the dominant currency.

A sharp devaluation is needed in the current situation. An excessively high exchange rate will put massive pressure on the economy and asset prices, and in the end the economy would pay a heavy price.

If the renminbi weakens further, the Hong Kong dollar could become the world’s strongest currency along with the US dollar. Local property investors would fret about that.

This article appeared in the Hong Kong Economic Journal on Aug. 12.

Translation by Julie Zhu

[Chinese version中文版]

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Columnist at the Hong Kong Economic Journal