China’s Yuan Puts Asian Central Banks on Defensive With New Risk

Updated on
Why China Let the Yuan Fall Further

Just as Asia’s central banks were bracing for an expected increase in U.S. interest rates, China has given them another headache to deal with.

The decision by the People’s Bank of China to let its yuan weaken by the most in two decades is creating a bind for policy makers grappling with slowing growth and sluggish exports. If they let their currencies follow to stay competitive, they risk reviving inflation and a rush of money exiting to the U.S. dollar.

“Devaluation is a beggar-thy-neighbor policy,” said Chua Hak Bin, an economist at Bank of America Merrill Lynch in Singapore. “Domestic demand is very weak in most economies in Asia. This could be a race to the bottom.”

First to follow -- the State Bank of Vietnam, which widened the dong’s trading band on Wednesday, citing the “negative impact” on its economy of China’s devaluation. The move marked an official confirmation of the fallout across Asia’s currencies, which had their biggest two-day selloff since 1998, during the region’s financial crisis.

Malaysia’s ringgit weakened beyond 4 to the dollar for the first time since 1998 on Wednesday. Indonesia’s rupiah slid the most since Dec. 15. Bank Indonesia views the rupiah’s recent declines as excessive, causing the currency to trade far below its fundamental value, Governor Agus Martowardojo said in a statement, adding the authority will remain in the market to stabilize the exchange rate.

Perfect Storm

“By actively depreciating the currency, China risks triggering further currency wars,” Gabriel Stein, Oxford Economics director of asset management services in London, wrote in a note. “Some countries are already acting.”

Yet central banks from Indonesia to Singapore have already eased monetary policy this year to support growth. A currency war gives them even less room to maneuver, as excessive weakening gives funds an incentive to flee.

Asia has been “hit by a perfect storm” of tighter fiscal policy, moderating credit growth, increased exposure to China and lower commodity prices, said Michael Wan, a Singapore-based economist at Credit Suisse Group AG. “Expect growth around the region to be quite lackluster.”

The region is in the midst of a deep “trade recession” that is likely to endure, Australia & New Zealand Banking Group Ltd. said in a note Wednesday. The bank cut its growth forecasts for India, Indonesia, Malaysia, the Philippines, Thailand and Singapore.

“Asia’s ability to consume will be diminished along with weaker currencies in the short term,” said Wai Ho Leong, an economist at Barclays Plc in Singapore. “We don’t know how much demand is destroyed by this currency move, how much producer confidence is lost.”

Weak Demand

Even currency weakening may not help these economies when shipments have been faltering all year due to slower demand in key markets such as Europe.

“In an environment of weak final demand, competitive devaluations are unlikely to have the effect that policy makers would expect them to have,” said Glenn Maguire, a Singapore-based economist at ANZ.

Taiwan is trying to find a middle path, quietly easing monetary conditions to spur growth and prevent capital flight as its currency plunges. The island’s central bank, which has kept benchmark borrowing costs unchanged since 2011, cut the rate on overnight certificates of deposit for a second day on Wednesday and said it will pay less on 14-day debt at a sale scheduled Friday.

The Monetary Authority of Singapore said late Wednesday it “stands ready to curb excessive volatility” in its dollar, even as the currency remains within the policy band set by the central bank. MAS said its policy stance of a modest and gradual appreciation announced in April remains appropriate.

Wait-and-See

While the International Monetary Fund said China’s yuan changes are a welcome step as they should allow market forces to have a greater role in determining the exchange rate, Asia-Pacific policy makers are bracing for volatility and uncertainty.

Philippine policy makers are in “wait-and-see” mode as the yuan may depreciate further and become more volatile, Bangko Sentral ng Pilipinas Deputy Governor Diwa Guinigundo told reporters Wednesday.

China’s yuan devaluation has caused the U.S. dollar to strengthen against other currencies, which may prompt the Federal Reserve to rethink the timing of rate increases, Indonesian Finance Minister Bambang Brodjonegoro told reporters in Jakarta.

“China’s moved quickly,” Australia Trade Minister Andrew Robb said to reporters in Canberra Wednesday about his nation’s largest trading partner. “The exchange-rate issue is an attempt to restore some competitive position. I don’t know what will happen next, I don’t think anyone does.”

No Panic

Still, a fresh round of currency wars is unlikely to sweep across Asia, according to Daniel Martin, senior Asia economist at Capital Economics Ltd.

“There is no need for Asian policy makers to panic,” Martin wrote in a note Wednesday. “So far, the drop in the renminbi has not been large enough to make much difference to export competitiveness, and we do not think the PBoC is looking to implement a series of competitive devaluations.”

South Korea’s Finance Minister Choi Kyung Hwan described China’s yuan weakening as a bid to support exports and said that his government is closely watching how currency markets respond. Any boost in Chinese shipments may ultimately help Korea given it sells mainly intermediary goods to China, Choi told reporters in Seoul.

Implications for Australia partly depend on what is driving the move, Reserve Bank of Australia Deputy Governor Philip Lowe said Wednesday.

“We know that movements in exchange rates often set off a chain reaction of events which can be difficult to predict, so I think we’ve all got to watch what’s going on very carefully, particularly in Asia,” he said.

“The PBoC’s move has added a new headache to central banks in the region,” said Le Xia, chief economist for Asia at Banco Bilbao Vizcaya Argentaria SA in Hong Kong. “If they want to maintain their competitiveness of exports, they need to pursue sharper depreciation,” even as doing so carries risks of higher inflation and capital outflows, he said.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE