Future Prospect of the Yuan
World leaders have very often charged China of staggering devaluation of the Yuan for leveraging the advantages in its exports and imports. Over the past few years, following the modest currency reforms in 2005, China, as indicated by several
forex brokers in the recent past, has tried to slowly but gradually stabilize the Yuan’s exchange rate with the Dollar i.e. to appreciate the Yuan with a view to attain a free-float exchange system (supposedly). However, the steady appreciation came to a halt with the onset of the recession in 2008. The Yuan was tied to the dollar which had appreciated against several other currencies, helped depreciate the currency in the market to pull up its fledging exports and FDI.
China fundamentally being an export-oriented market has leveraged the devaluation of its currency and in popular opinion will continue to do so in the period following the recession in 2008. But to solely base the argument of devaluation to the aid of falling exports also depends upon the contingence of the open-market status and certain protectionist legislation in its principle export markets.
China has also shown interest in transforming its export-oriented economy to a more domestic, self-sustaining unit in itself. But devaluation now, for the near-term will surely affect such a transformation by further constraining the dwindling local demand and throwing the economy to rely further on exports, which are already feeble in the current scenario. One must also take note of the fact that nay such devaluation will be done in the face of contracting global demand, the principle reason behind the drop in Chinese exports. The move will only trigger a series of competitive devaluations by other Asian countries that have statistically lost out more exports than china has. Hence, China’s trade competitiveness has most certainly not withered with the crisis. In short, these are strong arguments against China possibly devaluing its currency in future.
Devaluation will also most certainly not help a country with the one of the largest trade surplus in the world while global demand is not in commensuration with the rising surplus. In order to healthily sustain itself and its trade surplus, China requires manufacturing capacities globally to fall in the same ratio. But with markets picking up and most European countries reporting inspiring figures after the downfall, China may find itself a victim as did the US in the 1920s following the contraction in world trade as opposed to its rising surplus.
But from this it is also not safe to conclude the currency will slowly but surely appreciate. China’s economy has been failing since July 2008, reflected in the pessimistic trade and industrial data. With this, China has lowered its growth expectations and shifted priorities towards maintaining growth. This eats into the chances for further appreciation that will only result in widespread bankruptcies and job-losses. To this effect, Zhou Xiaochuan, Governor, People's Bank of China said “We do not preclude the possibility of promoting exportation and maintaining China’s economic growth by depreciating the RMB.” It has also been noted that since the subprime crisis, the US dollar has constantly appreciated and as a result, devalued the Yuan relatively. Thus, if the Dollar continues its upswing as it is, the Yuan’s devaluation is inevitable. Also, it has been argued that the Chinese Banking sector is burdened by spiraling bad debts, most of which remain undisclosed. Such an uncertainty will also build devaluation pressures on the Yuan.
Devaluation can have both encouraging as well as devastating effects on FDI, with China being one of the largest beneficiaries. On one hand, devaluation will induce greater capital inflows from the hike in the exchange value of foreign funds but that will also shrink the exchange value of the profits derived from these investments in China. More importantly, devaluation also poses the risk to China’s credit risk rating towards foreign borrowing. China extensively relies on foreign investments for its infrastructure and other development plans and these factors will be crucial to consider while dictating the currency movement.
From the above arguments, it is rather difficult to conclude or even assume the future direction of the currency. But there are certain identifiable factors in our opinion such as the porosity of export markets and the vulnerability of demand. While potential devaluation will obviously mean good news for the exports but like it has happened in the past will also lead to unbalanced economic development (fuel higher inflation, overinvestment in various sectors and expansion of nonperforming loans by the banks etc) and further diminution of the living standards in a country where nearly 40 million people live on less than $US 1 a day. Any such move is ambiguous in future.
