Daily Management Review

China Devaluation Raises Prospects of Currency War, Fall in Global Markets


Following a run of poor economic data, China surprisingly announced a 2 percent devaluation of the yuan on Tuesday. This move resulted in a worldwide impact on the share markets throughout the day.

This created prospects of a possible currency wars.

While the Chinese authorities claim this as a free-market reform but the analysts are of the opinion that but this could be the beginning of a longer slide in the exchange rate

Touching a lowest point in almost three years, the Chinese central bank set its official guidance rate down nearly 2 percent prior to market open to 6.2298 yuan per dollar from 6.1162 the previous day. Chinese official sources claim this to be a change in methodology to make it more responsive to market forces.

"Since China's trade in goods continues to post relatively large surpluses, the yuan's real effective exchange rate is still relatively strong versus various global currencies, and is deviating from market expectations," the central bank said.

Hit by weaker demand from Europe, the United States and Japan, China's exports tumbled 8.3 percent in July according to data that was released at the weekend. The data recorded that the producer prices are well into their fourth year of deflation.

Following the devaluation, there were global fall in the markets.  

Being worried about the implications of the move to support China's slowing economy and exports, investors got into selling spree that resulted in stocks falling in Asia and Europe.

After Monday's hefty gains, crude oil prices fell as the stronger dollar hit commodity prices.

China’s central bank described the move as a "one-off depreciation" and was based on a new way of managing the exchange rate that better reflected market forces.

The Australian dollar fell 0.9 percent to $0.7346 as the U.S. dollar rose 0.4 percent against a basket of currencies. The Australian dollar is often used as a liquid proxy for the yuan.

The Asian markets and currencies were the worst hits as the Singapore dollar touched a five-year low and the Malaysian ringgit and the Indonesian rupiah touched historic lows, the lowest since the Asian economic crisis 17 years ago. In Japan the yen also came down to a two months low 125.08 to the U.S. dollar.

However, following the Greek bailout agreement, the Euro managed to score a 0.2 percent rise to $1.1040.

Masafumi Yamamoto, senior strategist at Monex in Tokyo said: "devaluation of the yuan likely won't end here. Currencies like the Singapore dollar, South Korean won and Taiwan dollar which stand to compete with China, are falling and today's move could generate headlines heralding the start of a devaluation war".

In a step that would add strength of the US dollar, the US government is preparing to raise interest rates. Meanwhile Tuesday’s decision and the new exchange rate mechanism implemented by the Chinese central bank is expected to give markets greater ability to push the yuan lower even as the country’s economy is slowing.  

Though the Euro managed to gain some ground following the Greek debt agreement, there was fall in certain European markets. The pan-European FTS Eurofirst 300 index fell by 0.5 percent driven by car makers and luxury goods companies perception that the Chinese currency devaluation meant that their products would be costlier to the Chinese customer.

On the Chinese stock markets however, exporters gained momentum but share value of importers fell. There was a loss of 0.4 percent in the CSI300 index, the index for the largest listed companies in Shanghai and Shenzhen.

(sources:www.reuters.com & www.digitallok.com)