YUAN DEVALUATION- Why and its Affects on Singapore

China devalued its tightly controlled currency, roiling global financial markets and driving expectations the yuan could be set for further falls.

China’s devaluation may be best seen as a distress signal from Beijing policymakers – in which case the world’s second-largest economy may be far weaker than the 7% a year growth that official figures suggests. China has been trying to engineer a shift from export-led growth to an expansion based on consumer spending – while simultaneously trying to deflate a property bubble.

WHY???

The central bank said it took action because

• Yuan has been rising in value when market forces indicated it should have fallen.
• Yuan has been pushed up because its exchange rate is heavily influenced by the US dollar, which has been strengthening on expectations of a hike in US interest rates.
• But the devaluation is widely seen as a move to bolster the economy which is struggling to achieve its 7 per cent growth target. This move will help exports to improve.
• Over the weekend, China reported that its exports plunged by an unexpectedly wide margin of 8.3 per cent in July. The currencies of other developing countries have also fallen, making Chinese exports relatively more expensive.

Leading to Currency wars.....

Currencies fell on fears a weaker yuan could threaten other economies in the region that compete with Chinese exports and encourage their central banks to devalue their currencies to stay competitive.

Ironically, while the much-talked-about devaluation of the renminbi has been a mere 2.8% so far, many currencies in Asia and emerging markets (EMs) have seen a far greater depreciation over the same period, as you can see from the chart.

Sierra Leone’s leone slumped 20%, the Kazakhstan tenge plunged 20.17%, while Malaysia’s ringgit, Russia’s rouble, Turkey’s lira and the Mexican peso all fell between 4% and 7%, as you can see from the chart. The Indian rupee, Taiwanese dollar and Vietnamese dong have all declined more than 3% since 7 August.

WIDER ECONOMIC IMPLICATIONS

• Depreciation of other Asina currencies - It could also result in a new Asian currency war. Yuan devaluation puts pressure on other central banks around the world to push down their own currencies to help their own exporters and to prevent destabilising capital flows.
• Delay in increase in US interest rate - It could delay a highly anticipated hike in US interest rates by the Federal Reserve. The yuan's devaluation has put even more upward pressure on the US dollar. Continued dollar strength is problematic for the Fed since it hurts exports and lowers inflation as well as weakens corporate profits.

Affects on Singapore

• Singapore’s economy shrank by 4% in Q2/2015 due to the SGD’s strength against most of our major export markets which is led by China, Malaysia, Hong Kong, Indonesia, Europe and US.
• In two days of devaluation, the People’s Bank of China wiped out the Singapore dollar’s relative weakness against the yuan that the MAS engineered for Q3/2015. However the MAS cannot simply follow the China’s move to regain that export edge.
• While a weaker SGD would stimulate our exports, it also means higher interest rates for homeowners when the U.S. Fed is poised to raise interest rates. The recent Chinese devaluation weakened the SGD and caused the 3-month SIBOR to spike 6.3% in one day.

China may further depriciate Yuan. Such prolonged uncertainties will affect business and consumer confidence, which will slow down consumption and economic activities. If these happen, the broader economy may be further hurt at a time when global outlook remains sluggish.

Singapore slashed the upper end of its previous 2 to 4 per cent annual growth forecast, amid ongoing risks from an uncertain external environment and a slowdown in global trade, and market watchers have cautioned of an equally cloudy outlook in the coming months.

An export-dependent country; a downward pressure on exports can be seen, the Purchasing Managers’ Index readings on new orders and new export orders, which, in turn, will have an impact on production and export figures.

If we take a look at the Singapore dollar nominal effective exchange rate, it has moved towards the bottom of the policy band, suggesting even more loosening of the monetary policy for the economy.