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Explainer: How China's Devaluation Could Affect Other Currencies

  • Charles Recknagel

China's devaluation of its renminbi (also known as the yuan) could have knock-on effects on other currencies. Here are three things to know about the potential repercussions.

How will other currencies be affected?

Beijing's sudden devaluation of its renminbi by 2 percent on August 11 -- the most in two decades -- has raised fears that it signals a slowdown of the Chinese economy that could mean a shrinking demand for oil in coming months. The move, along with greater OPEC production output, immediately sent oil prices tumbling, with the U.S. benchmark price for oil falling to $43 a barrel, its lowest level in more than six years.

That was bad news for Russia, already reeling from a steep decline in global oil prices over the past year and from financial sanctions imposed by the United States and EU over Ukraine. Since any drop in oil prices weakens the ruble, whose value is closely tied to the country's energy exports, the Russian currency immediately lost value on August 12, hitting a rate of more than 64 rubles per dollar.

Other countries relying on exports of energy and other commodities also saw their currencies buffeted by the news of China's devaluation and fears of reduced demand.

However, the countries whose currencies may react the most strongly to China's action may not be commodity exporters but those nations -- mostly in East Asia -- which directly compete with China in exporting manufactured goods to the world market. Beijing's devaluation will makes China's export goods cheaper, and its rivals may now have to follow suit.

How long could a knock-on effect last?

The question for commodity producers is whether the fears about China's economic health and reduced global demand persist or die down.

Many analysts see Beijing's action as an effort to stimulate its economy which posted a 7 percent growth in gross domestic product (GDP) during the first and second quarters of this year, the slowest pace in six years. Devaluating the renminbi and making exports cheaper could help by reversing a decline that saw Chinese exports tumble 8 percent in July compared to last year.

William Jackson, an emerging markets economist at London-based Capital Economics, says he does not see fears of a shrinking Chinese demand for oil lasting long.

"It is not clear that China would suddenly stop demanding as much oil as it had done previously,” Jackson said. “We think the Chinese economy is likely to hold up pretty well over the next few quarters, so I think oil demand from there should not change particularly."

China itself says its devaluation is not about stimulating a slowing economy, describing it as a one-time move to enhance "the market-orientation and benchmark status" of the renminbi. That comes as China hopes to see the International Monetary Fund (IMF) accord the renminbi the status of a global reserve currency in a review later this year. China's central bank, which has previously set the exchange rate for the currency through constant intervention, said it will now give the markets more of a voice. That gesture could strengthen Beijing's argument to the IMF that its currency meets conditions for being a transparent and reliable medium for international trade.

Is there anything else to consider?

Some analysts say that for most emerging market countries, particularly those outside of Asia, to worry too much about knock-on effects from the renminbi on their own currencies is misguided. That is because a far greater knock-on effect comes from the strengthening of the U.S. dollar, something of which the drop in the relative value of the renminbi to the American currency is only the latest sign.

For many countries, including Russia, the seemingly ever-strengthening dollar drives up the cost of paying international debts, which are often denominated in the U.S. money. It also makes the cost of obtaining more dollars more expensive.

Charles Robertson, global chief economist at investment bank Renaissance Capital in London, says the problem becomes particularly significant for emerging market countries when their own currencies are weak and when commodity prices are down.

"When all three things are happening at once -- emerging market currencies falling off against the dollar, commodity prices going down, and the external debt stock becoming more problematic -- that, I think, is more problematic for most emerging markets than China's currency moving a couple of percent,” Robertson said.

The U.S. dollar has been strengthening since last year, driven by improved performance of the American economy and is likely to grow stronger if the U.S. Federal Reserve raises interest rates later this year, as it has hinted it might do. One effect of an interest rate hike would be to make the U.S. dollar more attractive to global investors as a safe haven at a time when so many other currencies are weak.

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