Here’s Why a Near-Term Yuan Devaluation Is Unlikely
Amid rising vulnerabilities to the global economy, world financial leaders and investors fear a disorderly China’s yuan devaluation could trigger a much larger global selloff, potentially pushing the global economy back into recession.
That’s a key reason why finance ministers and central bankers from the Group of 20 largest economies meeting in Shanghai this weekend want the G-20 to reiterate past vows to avoid competitive devaluation.
But there are a number of good reasons to think any potential significant yuan devaluation by China wouldn’t come until the end of this year at the earliest, if at all.
Some G-20 officials push back against the notion that China will depreciate, saying a devaluation not only goes against the messaging of China’s leaders, but comes with collateral damage.
It could send a bad signal to markets, suggesting Beijing was worried the slowdown was metastasizing into a nosedive and that it resorted to a last-chance policy move. Panicked markets could force the yuan to weaken more than Beijing planned.
Preventing a yuan devaluation—a costly exercise against large capital outflows and investor selloffs in Hong Kong yuan markets—is partly a message from Beijing’s leadership about their confidence in the economy and their ability to manage their economic transition.
A weaker yuan would also undermine Beijing’s efforts to move to a more consumer-oriented economic model by eroding their buying power.
And it could exacerbate the country’s mounting debt problems: A hefty portion was borrowed in dollars. A devaluation would make that debt–already strained–that much more difficult to pay off.
Still, officials and economists are watching what Beijing does as much as what it says. That’s why even though comments by Chinese officials in the run-up to the G-20 go some way in reassuring that the Asian behemoth won’t revert to currency depreciation to revive growth, the yuan’s recent trading still fuels doubts.
Along with investors and economists, many officials around the world aren’t certain what exactly China’s exchange-rate policy is.
Beijing last year broke the yuan’s peg to the dollar and has said it is moving toward targeting a basket of currencies. The yuan has wavered between tracking the dollar’s movements and the basket of currencies, however.
That feeds uncertainty about China’s exchange-rate policy, whether Beijing is still keeping its options open for a major yuan devaluation and whether reformers will be outmaneuvered by Communist Party interests who want a balm for a deteriorating manufacturing position and weakening output.
“Are they truly going to keep the yuan stable against a basket with market forces generating sustained large capital outflows?” asked Charles Collyns, managing director of the Institute of International Finance and a former senior U.S. Treasury diplomat. “I don’t think markets are yet convinced.”
Investors are wary about Beijing’s ability to stabilize the yuan’s value without ratcheting-up capital controls or tightening monetary policy. “It’s not clear how much longer the “impossible trinity” can be avoided,” the IIF said in a research note.
Some China watchers point to late this year as a possible time frame for a yuan devaluation: Global peer pressure will dissipate after the G-20 leaders’ summit in September and Beijing will have a better sense then about how fast the economy is slowing.
And if it continues to burn though foreign-exchange reserves at the same pace is has over the last year, its currency stocks would have reached uncomfortable levels. Then, if Beijing feels the economy is tumbling out of control, it may resort to a depreciation, argue some economists.
Until then, there may only be a trending fall in the yuan’s value.
“Beyond the near-term, we believe the RMB will likely weaken moderately on a broad basis, given the challenges on the cyclical front and in China’s balance of payments,” HSBC’s global research team said in a client note, using another name for the yuan, or the renminbi.
“We expect China to increasingly allow the exchange rate, rather than overly rely on FX reserves, to respond to capital outflows.”