19 April 2019
Whether there will be another sharp yuan devaluation largely depends on any further strength in the US dollar. Photo: Bloomberg
Whether there will be another sharp yuan devaluation largely depends on any further strength in the US dollar. Photo: Bloomberg

Why a second wave of RMB depreciation is coming soon

The renminbi has shown signs of stabilizing after its surprise devaluation in the previous week. Does this mean the decline has wound up?

The People’s Bank of China has dismissed market fears of further moves to sharply devalue the yuan, saying the claim was a “complete nonsense”.

However, such worries continue to prevail in the market, and market participants are still divided over the redback’s outlook.

In fact, whether there will be another sharp yuan devaluation largely depends on any further strength in the US dollar, which is closely linked with the US Federal Reserve’s rate lift-off.

The Fed started winding up its QE3 stimulus program in mid-2014, and this drove the dollar index to surge over 25 percent until the first quarter of this year. The index has started to consolidate since then.

The greenback is expected to surge again if the Fed starts to normalize the interest rate this year, which has a likelihood of over 70 percent.

In early August, the US trade weighted broad dollar index has already started to go beyond the peak level reached early this year, while some emerging market currencies have touched record lows.

Beijing has the capability to stabilize its foreign exchange rate within a certain range on the back of its US$3.7 trillion foreign exchange reserve and relatively closed capital accounts. That has stemmed the massive external attack on its currency.

However, other Asian nations as well as emerging markets are likely to be drawn into a currency war if there is another US dollar rally.

If that happens, the daily fixing of renminbi will again deviate from the market level. That will prompt Beijing to make another “one-time” adjustment.

Meanwhile, technical analysis shows that the dollar index is very likely to break its current range-bound movement in September.

We will have more clues on the schedule for US rate hike and further dollar strength after the meeting between Chinese leader Xi Jinping and US President Barack Obama next month as well as the next meeting of the Federal Open Market Committee.

It’s possible that another wave of currency depreciation competition or even a financial crisis could occur in September.

The yuan devaluation will exert limited boost for China’s economic growth. Exports to its four largest trading partners have already slumped to new levels since the financial crisis, in a sign of sluggish external demand.

Other nations are likely to weaken their currencies if the renminbi posts another sharp depreciation, which would offset its real impact and offer very limited help for China’s export growth.

Last fiscal year’s financial data shows that overseas income contributed only 17.3 percent of the revenue of 1,000 non-banking companies in the Shanghai Composite Index. Another yuan devaluation will offer very little help for these companies.

So although the Chinese central bank has dismissed fears of further deep yuan depreciation, market confidence has not been restored.

If there is another US dollar rally, it is inevitable that the daily fixing of the renminbi will again deviate from market levels.

By then, there will be pressure on China to make another “one-time” adjustment to its currency.

This article appeared in the Hong Kong Economic Journal on Aug. 20.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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