Download Economics China`s currency devaluation is actually a

Economics
China’s currency devaluation is actually a positive
ʀ Worries about China’s currency devaluation are overstated. In recent years,
China’s yuan has appreciated significantly on a trade-weighted basis and its unit
labor costs of production have soared, cutting into China’s competitive edge and
contributing to declining exports. A modest depreciation of its currency is an
appropriate adjustment that is positive for China’s economy and global
performance.
ʀ China’s economic growth is slowing gradually – continuing a trend of the last
several years – and the transition toward more reliance on consumption and
services is proceeding rapidly. The probability of a hard landing remains low.
ʀ Consumers have a lot of purchasing power and the government will continue to
implement further monetary and fiscal stimulus aimed at boosting domestic
demand, offsetting the weakness in exports.
ʀ News on China’s data and economic surveys must be put into the proper
perspective: indicators that focus on China’s export-related manufacturing
sector, like the PMI, can be expected to be negative, while indicators of consumer
spending remain healthy. These reflect the transition in China’s economy.
ʀ It may take a while, but eventually markets will become comfortable that China
is not heading toward a hard landing, and that the negative responses to China’s
modest currency devaluation have been excessive.
China, market turmoil
and US implications, 27
August 2015
The PBoC’s easing and
financial reforms, 26
September 2015
Global Economic
performance: influences
of China, commodity
prices and currencies,
currencies, 29
September 2015
Global outlook 2016: the
critical issues, 6 January
2016
China’s currency depreciation is generating worries in global financial markets on a
number of fronts: that China’s economy is slowing faster than desired; that a Chinese
devaluation would harm foreign producers; or that it may elicit a damaging currency
war. These quick response market worries are vastly overstated. China’s economic
growth is slowing – a trend that began several years ago – but is not collapsing.
China’s exports are now declining, and its policy of allowing its currency to depreciate
modestly following several years of significant appreciation on a trade-weighted basis
is reasonable. Its additional monetary and fiscal stimulus similarly are appropriate
policies to manage the gradual deceleration in growth and facilitate the desired
transition toward a more consumer- and services-based economy.
China’s devaluation is orderly and a necessary adjustment that better aligns China’s
currency to its economic and financial fundamentals, including its faltering exports
and sharply rising unit labor costs relative to foreign competitors. To the extent it
helps to support China’s growth, it benefits China’s trading partners and global
economic performance.In this regard, China’s currency depreciation is part of China’s
solution and is not negative.
Clearly, following several years of stunning growth during which China became the
world’s second-biggest economy and its engine of growth, and the manufacturing hub
of Asia, China’s growth deceleration and transition toward a more consumer-based
economy will involve both internal and external adjustments. Global trade flows will
be affected and a somewhat weaker currency can be expected. Global markets are
recoiling at the recent sharp, disorderly declines in China’s stock market, but in reality,
the market had risen too fast in the first half of 2014 in response to explicit
government policies to pump up stock prices, and is now adjusting back to reality. In
fact, the Shanghai composite stock index is now 50% higher than in mid-2014. It may
take time for markets to adjust to China’s economic transition and the beneficial
effects of an orderly currency adjustment.
1. We maintain our outlook that China’s economic growth will decelerate
gradually and transition rapidly toward more reliance on domestic
consumption and services.The probability of a hard-landing remains low.
Mickey D Levy
Chief Economist, US, Americas and Asia
+1 646 445 4842
[email protected]
7 January 2016
Economics
Following years of robust growth, China’s exports are now falling modestly and its
export-related manufacturing is faltering. (Note that while China’s exports are
declining, its imports are declining more rapidly, so for now GDP is growing faster
than domestic demand.) Meanwhile, domestic consumption and services continue to
grow rapidly, and households have accumulated significant purchasing power from
several decades of rapid gains in personal income and extraordinarily high rates of
personal saving. This will support sustained strong consumer spending. The
government will take additional steps to stimulate consumption.The lifting of ceilings
on yields on deposits in state-owned enterprise (SOE) banks and other financial
reforms will increase personal income over time.More monetary and fiscal stimulus
(primarily infrastructure spending) are expected as the government attempts to boost
domestic demand to achieve GDP targets. Accordingly, China’s economic transition
will continue to proceed rapidly, albeit with some bumps along the road.
Source: China Customs/Haver Analytics (top); China National Bureau of Statistics/Haver
Analytics (bottom)
2. China’s currency is overvalued relative to its shifting economic performance, and
will be allowed to depreciate further. China’s sustained dramatic rise toward
becoming Asia’s manufacturing hub and the world’s largest exporter of goods
generated large demands for labor that pushed up wages in excess of productivity and
resulted in sharp increases in unit labor costs.At the same time, China’s currency has
appreciated significantly on a trade-weighted basis. The combination of rising
operating costs of production and a stronger currency have begun to dull China’s
competitive edge. The fall in exports increase the difficulty of achieving a smooth
transition toward more reliance on consumption and services while maintaining a
high rate of GDP growth. Monetary and fiscal stimulus may directly boost domestic
demand but such policies do not directly address China’s primary weakness, its
declining exports. With productivity gains ebbing, a weaker currency is an effective
mechanism to stabilize China’s exports. Under current conditions, if the currency does
not depreciate, an “internal depreciation” can be expected in the form of lower real
wages.
2
Economics
Source: CSSB/CNBS/MoLSS/Haver Analytics
3. Economic indicators of China’s export and manufacturing sector have been
decidedly poor, while indicators of China’s consumers have been decidedly more
upbeat.China’s PMI survey index indicates declining manufacturing activity.While not
a surprise, it is a disappointment to markets that had come to rely on China’s booming
manufacturing. However,indicators of China’s consumer and services sectors remain
healthy. Amid China’s economic transition, it is important to put the data and survey
results from different sectors in their proper perspective. Most likely, nervousness will
prevail until skeptics are convinced that China will not incur a hard landing, and that
may take a while.
4. As a large and open economy, with exports and imports sizeable portions of GDP,
China’s currency plays an important role in influencing its international trade and
capital flows. In the years before mid-2005, the Chinese yuan was pegged to the US
dollar at a low exchange rate as part of China’s policies to stimulate exports. Since
then, its value versus the dollar has been closely managed by the Peoples Bank of
China (PBoC). Through year-end 2014, the yuan was allowed to appreciate versus the
dollar (from 8.3 yuan/US dollar to 6.15 yuan/US dollar). In August 2015, the PBoC
announced abruptly a minor depreciation to 6.33, and since then it has depreciated to
6.6 yuan/US dollar. With the US dollar appreciating versus the euro and yen, and by
even more versus some emerging nations that are significant trading partners with
China, the yuan has appreciated significantly on a trade-weighted basis; since mid2011 it is up by approximately 28%. At the same time, exports have flattened, private
business investment spending and foreign direct investment in China have slowed,
and some modest financial reforms that have begun to liberalize restraints on crossborder flows have allowed net capital outflows from China. These economic and
financial trends suggest that China’s currency is overvalued.
Source: Federal Reserve Board/Haver Analytics
3
Economics
Source: JP Morgan/Haver Analytics
5. An appreciation of the yuan would improve China’s relative costs of production
versus its trading partners, but all of China’s trading partners would be better off if a
depreciation of the yuan helps to stabilize China’s tradeable goods sector and
improve its economy. It is fully understandable that skeptics believe such policy
actions reflect desperate actions by Chinese leaders to avoid undesirable economic
weakness or that they may undercut the effectiveness of foreign manufacturers that
are already burdened by a host of economic challenges. However, not responding to
current conditions would be a costly mistake. As China transitions its economy, a
moderate currency depreciation, under the circumstances, seems to be a reasonable
and positive economic adjustment. It may take time, but eventually markets will sort
out these adjustments and come to realize that its initial responses were excessively
negative.
4
Economics
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passage of time and/or as a result of legal, political, economic or other changes. We do not assume responsibility to
indicate such changes and/or to publish an updated document. The forecasts contained in this document or other
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