China’s devaluation of the renminbi

27 Aug 2015

By Shadforth Financial Group

On 11 August 2015, the People's Bank of China (PBOC) surprised the market by devaluing the renminbi (RMB) against the U.S. dollar by 1.9 per cent. The devaluation was the biggest one-day move in two decades. Subsequent moves have seen the cumulative devaluation reach 4.4 per cent at the time of writing.

China's devaluation stems in part from a desire to let markets influence the price of the renminbi, a shift global policy makers have encouraged. If managed well, it may provide China with the extra flexibility it needs to deal with the challenges facing its economy.

The weaker renminbi will help Chinese exporters as products manufactured in China become cheaper for importing countries.

While the weaker renminbi should help boost economic activity in China, policy makers need to ensure the currency remains stable to prevent capital outflows that may weaken the country's economy further.

One of the main reasons that China has to avoid a sharp devaluation of the renminbi is that Chinese entities have borrowed more than $1.6 trillion in foreign currencies. A significant drop in the renminbi would increase the pressure on these companies as they would need to earn more renminbi to service their interest payments.

Despite the devaluation of the renminbi, economists are still expecting the PBOC to deliver a further interest rate cut in the third quarter of 2015 and more cuts to the Reserve Requirement Ratio for the banks. The Chinese government is also expected to accelerate the pace of spending. These moves should further stimulate the Chinese economy.

The U.S. Federal Reserve now faces a dilemma as it contemplates raising interest rates for the first time in more than nine years. A rate increase could drive the U.S. dollar up even more against other currencies, which could impact the country's recovery.

Impact on Australia

The devaluation of the renminbi impacts Australia as 32 per cent of our exports by value go to China. The vast majority of these exports are commodities, with iron ore and coal representing 35 per cent of goods and services exported. Devaluing the renminbi makes imports of Australian commodities more expensive, which could reduce demand.

China is Australia's largest single market for service exports, representing 13 per cent of total services exported (Tourism and Education). This compares to the U.S. at 11.2 per cent and the U.K. at 7.3 per cent. Around 125,000 Chinese students now study in Australia. Chinese tourists visiting Australia have also risen substantially, now representing 84,000 visitors per month.

The potential for lower growth in Australia and a benign inflation outlook could see interest rates remain lower for longer, with the Reserve Bank of Australia potentially cutting interest rates further.

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