Why The Chinese Yuan Is Weakening Against The Dollar

With the sudden depreciation of China’s renminbi, it’s worth looking at the link between currency values and trade agreements. China’s currency dropped by a cumulative 4.4% against the U.S. dollar in August 2014 and in January 2016, the depreciation even going further, making Chinese exports cheaper and imports into China more expensive by that amount.

China’s latest currency move has drawn muted responses from the IMF and U.S. Treasury. As quoted in The New York Times (http://www.nytimes.com/2015/08/12/business/international/china-renminbi-currency-devaluation.html), the IMF said “China’s new plan for determining the value of the renminbi ‘appears a welcome step as it should allow market forces to have a greater role.’ But the IMF also carefully noted that “the exact impact will depend on how the new mechanism is implemented in practice.” The U.S. Treasury’s statement followed a similar line (http://fortune.com/2015/08/19/what-chinas-currency-devaluation-means-for-the-worlds-trade-deals/).

U.S. Dollar Vs. Chinese Yuan

During the period from 1997 to 2005, the China used conventional dollar dollar peg system, and the Chinese yuan was valued at approximately 8.3 CNY per U.S.dollar. (http://www.investopedia.com/articles/forex/082015/chinese-yuan-360-degree-analysis.asp)In 2005, the Chinese government transitioned to a managed floating rate system and revalued the CNY to 8.1 per USD. Under this system, the yuan’s value is determined by using basket of currencies with the central bank having a decisive control over its valuation against other currencies. Since then CNY getting stronger until 2014 when the lowest point is 6.15 CNY per U.S. dollar. Below is the currency exchange rate of Yuan against U.S.Dollar. from 2006 to 2016.

yuan is weakening against the dollarHowever, since 2014, the People’s Bank of China (PBOC) implemented free-market reform, and the Chinese yuan start to show the trend of weakening against U.S. dollar.

Economists and currency traders said it is an improvement over the previous system, since opening rates are more explicitly linked to the prior day’s closing level. As per the International Monetary Fund (IMF), China’s currency is not undervalued despite this devaluation. Goldman Sachs said the yuan devaluation “has been important for commodity markets and they believe it signals that global macro conditions have changed”.

Many U.S. policymakers focusing on bilateral trade with China want to argue that the Yuan is still substantially overvalued, while others who consider multilateral trade relationships, like the IMF, believe that the exchange rate is very close to fair market value. Obviously, exact quantitative precision on such matters is nigh impossible, but it is interesting that there are some who believe that if China were to concede to U.S. demands in letting its currency float, it is possible that the Yuan depreciates rather than appreciates.

The Forecast of the value of Chinese yuan (2016-2020)-Trading Economics

The Chinese Yuan is expected to trade at 6.77 by the end of this quarter (3/31/2016), according to Trading Economics global macro models and analysts’ expectations. Looking forward, we estimate it to trade at 7.04 in 12 months time. 

Global impact of the devaluation of Chinese yuan

1) A cheaper yuan will make Chinese exports less expensive, potentially boosting the overseas sales that have been among the main drivers of growth during the nation’s remarkable rise over the past three decades.

2) The devaluation of Chinese yuan has raised the risk of a “currency war” as export rivals seek a weaker exchange rate to stay competitive, according to Stephen Roach, a senior fellow at Yale University and former non-executive chairman for Morgan Stanley in Asia.

3) The devaluation has an overall negative impact on the automobile industry. Especially many European luxury auto manufacturers are being hit particularly hard. The yuan’s drop relative to the euro has been greater than its fall against the dollar. Chinese auto ventures such as BMW Brilliance Automotive Ltd. and Beijing Benz Automotive Co. Ltd., which import about half of their components from Europe and elsewhere, face downward pressure on margins.

Ruiqing Zhang
MBA Candidate 2016