Date
28 March 2017
The continued depreciation of the renminbi could trigger another round of competitive currency devaluation in Asian and other major economies. Photo: HKEJ
The continued depreciation of the renminbi could trigger another round of competitive currency devaluation in Asian and other major economies. Photo: HKEJ

Rising risk of competitive currency devaluation as RMB slumps

Equities worldwide slumped on the first trading day of 2016.

Disappointing manufacturing data in China stoked fears about the outlook for the country’s economic growth.

China’s domestic stock market suspended trading when its new circuit breakers were triggered.

The feud between Iran and Saudi Arabia has revived a flight to safe havens and weighed on US equities.

The Dow Jones industrial index posted the worst start for a year since 2008.

A Chinese purchasing managers index slipped 0.4 percentage points from the previous month to 48.2 in December.

The benchmark has hovered in contraction territory for 10 months in a row.

The Chinese central bank then weakened the daily fixing of the redback, reflecting a greater tolerance of a weaker renminbi.

The currency tumbled more than 1.5 percent against the US dollar over the year’s first four trading days.

The official daily fixing fell 700 basis points, while at one point the offshore renminbi dived 1,920 basis points, or almost 3 percent.

That reflects that China’s economic growth is weaker than expected, and it could trigger another round of competitive currency devaluation in Asian and other major economies.

The spread between the onshore and offshore market in the renminbi widened to 2 percent because of China’s capital controls.

However, that may not be sustainable for long, as China needs the onshore and offshore foreign exchange rates to converge as part of its efforts to internationalize the renminbi.

The onshore and offshore markets will converge if Beijing lifts controls over the capital account.

However, the heightened currency fluctuations that will result may exacerbate the plight of Chinese companies and even accelerate capital outflows.

Instead, the Chinese central bank might intervene from time to time using its massive foreign exchange reserves to prevent a drastic depreciation of the renminbi.

The prolonged decline in oil prices, coupled with rising geopolitical risks, has revived safe-haven demand.

The 10-year US treasury yield has dropped to 2.15 percent, the lowest since mid-December.

The Japanese yen outperformed as investors sought safe-haven assets.

The yen strengthened at one point to a four-month peak of 117.66 against the US dollar.

Diminishing expectations for further monetary easing by the Bank of Japan could further drive up the yen, which is likely to hover in the range of 116 to 121 to the US dollar in the first quarter of this year.

A senior Fed official hinted that there would be four rate hikes this year despite market turmoil at the start of the year.

However, it remains unclear whether financial turmoil and geopolitical uncertainty will derail the pace of US rate hikes.

The latest minutes of the US Federal Open Market Committee shed light on the internal debate over which priority takes precedence, and future rate moves will become data-dependent.

Inflation in the United States has stayed below the targeted 2 percent for more than 3 years, and core inflation only reached 1.3 percent in November.

A rate hike in March is unlikely given easing inflation in recent months.

That would cap the upside for the US dollar in the coming months.

This article appeared in the Hong Kong Economic Journal on Jan. 8.

Translation by Julie Zhu

[Chinese version 中文版]

– Contact us at [email protected]

JZ/DY/FL

Senior investment strategist and vice president, treasury & markets division, DBS Bank (Hong Kong)

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