In August 2015, China devaluated its currency the YUAN sparking an international debate on whether this move will lead to a new financial crisis. During that month, headlines from all over the world included three words “YUAN”, “Financial”, and “Crisis”, leading to a turmoil on global markets. Five months have passed, and the stock market is yet to recover. This change in the Yuan had a global impact; what should have been a national problem, a slowdown in China’s economy, became a problem of the international community.
Exploring the devaluation of the Yuan
On August 11, 2015, the People’s Bank of China (the “PBOC”) devalued the country’s currency by about 1.9% against the U.S. dollar. As the central bank, the PBOC said in a statement that the Yuan’s midpoint has diverged quite a bit from the market rate for a relatively long time and that it was time to make the midpoint more market-based. Economists and financial analysts reported several reasons behind that shift, such as the slow economic growth, political reasons, and to keep capital from flowing out of China. China was previously exploring alternative strategies to reform its economy. In April 2015, the Wall Street Journal reported that China has been making several efforts to strengthen its currency. The central bank purchased the Yuan in the currency markets and sold U.S. dollar holdings, asserting that China was aiming to stem capital outflows from China. The Yuan is strongly related to the dollar, as the latter rises the Yuan also rises.
The move to sell U.S. dollar holdings was an attempt by Chinese authorities to have the Yuan labeled a reserved currency by the International Monetary Fund (the “IMF”) which did eventually take place in November 2015. This change is a first step to drive the currency toward more market-driven movements, an overhaul requested previously by the IMF to help China achieve its goal.
Moreover, the devaluation could also help increase Chinese exports. The Chinese government reported that its exports had fallen 8.3% in July from the previous year. Bloomberg Business reported that “the devaluation came days after data showing a big decline in exports. A mix of interest-rate cuts and fiscal stimulus to spur growth has struggled to gain traction. However, the move meant to strengthen the Chinese economy sent threatening ripple effects in emerging markets such as Brazil and Turkey. China’s economy and financial structure have been the protagonist element of the world’s economy and have affected financial policies all over the world. Reuters reported that the Federal Reserve delayed an initial interest rate rise in September 2015 when a market sell-off in China triggered a fall in U.S. stocks. Therefore, will China’s policies trigger a financial crisis in 2016?
Present Market Turmoil
Several months have passed, and the ripple effects of this devaluation are ongoing. The Wall Street Journal reported again in the first few weeks of 2016, that the PBOC has made efforts to guide the price of the Yuan down, then build it back up again. The Chinese government has navigated its policy to manage the Yuan according to its performance against a basket of global currencies, and not just against the U.S. dollar.,
The depreciation of the Yuan continues to be a controversial topic. Some agree with China’s move while others are still criticizing it and blaming the volatility in China’s equity for it. One thing analysts agree on is that the whole financial market has been, and remains, rattled. Not to mention that shares are traded for a frothy price relative to their earning, they could have further to fall. This high valuation makes it difficult for investors to forecast when the current market slide will end.
On January 15, 2016, China’s main stock benchmark entered a bear-market. The Shanghai Composite Index fell 3.6% to 2900.97, dropping 20% from its recent high hit on Dec. 22. Elsewhere, Hong Kong’s Hang Seng Index was down 1.4%, Australia’s S&P/ASX 200 fell 0.3%, and South Korea’s Kospi slipped 1.1%, a few examples of the performance of the Asian market.
Investors are concerned with China’s increasing capital outflow and the use of its reserve of foreign currency to try to tame the Yuan’s movements. Analysts predict more volatility in the months to come. Chinese stocks already suffered a spectacular crash over the summer of 2015, wiping out trillions of dollars in value and hurting the millions of individual investors who had invested their savings into the market.
While China’s economy is transitioning and shifting to a more service-driven growth and a shorter-term cyclical adjustment, it is also slowing from the rapid expansion of recent decades as officials try to wean off a reliance on exports and debt-fueled investment in favor of consumer-led demand.
As the new year kicks off, China’s stock market can be qualified as unbalanced due to the state of the country’s economy and Beijing’s failed efforts to stabilize the financial markets. In a recent statement, China’s Chief Securities Regulator Xiao Gang blamed the “abnormal volatility on an immature market, inexperienced investors, imperfect trading system, flawed market mechanisms and inappropriate supervision systems.” The question remains as to whether the second largest economy in the world will be the fundamental reason for a global financial crisis.