By Ric Spooner, Chief Market Analyst, CMC Markets Australia.
There has been a quiet Yuan devaluation against $US recently. This is an interesting development and might be worth keeping an eye on
Yuan Devaluation Dilemma
China’s authorities propped the Yuan up against the $US after the one off devaluation in August. It looks like this was done as part of China’s strategy to have the Yuan approved as Special Drawing Rights (SDR) currency by the IMF.
Many analysts believe that keeping the Yuan relatively pegged to the US Dollar has caused it to become well overvalued. Estimates of overvaluation are in the range of 15-20%. The Dollar weakness over the past week has only been a marginal and possibly temporary improvement. It’s pretty clear that allowing the Yuan to devalue could provide a big boost to China’s economy. It would improve flagging exports and help get inflation closer to its 3.5% target.
The problem is that there might be costs to devaluation. One might be a perceived loss of credibility. Perhaps more seriously, it may make it more difficult to attract foreign capital or manage capital outflows. Investors are not going to stay put if they think they are about to lose 20% via a currency devaluation.
The IMF formally approved the Yuan’s inclusion in the SDR basket on 30 November. Now that this status symbol has been achieved, it appears Chinese authorities have been allowing a little bit of devaluation. This has begun to attract market attention.There have also been stories in the press in recent days.
This quiet devaluation is reflected in the offshore market and our USDCNH CFD
chart. Note the $US is the fixed currency in this pair. Price rises when the Yuan is devaluing and vice versa.
Many believe that this little devaluation has been about the testing the waters to see if some very gradual depreciation can occur without causing too much concern. Some even see this as an advance move on more significant devaluations next year. Others are not so sure. They believe China can easily afford to use its vast FX reserves to keep the exchange rate relatively stable and will do so in the interests of managing capital outflows and saving face.
Yuan devaluation would have implications for commodities. The immediate impact would be to make commodity imports more expensive. This would be a potential negative for commodities like iron ore, coal and copper. However, China’s exports and overall economic growth could be helped by devaluation. Over time this might partly offset the negative price impacts for commodities