On Tuesday and Wednesday, the People’s Bank of China (PBoC) devalued the renminbi by almost 4 percent, the most significant two-day devaluation since the mid-1990s. While the markets speculated whether this signaled the beginning of a currency war, the devaluation is not really the important story.
Strong Renminbi in Recent Years
First, the renminbi has appreciated against most currencies. It has held up well against the strong U.S. dollar in recent years and over the past year has appreciated more than 10 percent against the euro, the currency of China’s largest trading partner.
Slowing Chinese Economy
Second, the critical story behind China’s devaluation has been the acute slowdown in China’s economy, particularly in its export sector. While China sailed through the 2008–2009 recession following a massive stimulus package, its export sector has not been a significant source of growth since then. The current account surplus has shrunk from 10 percent of gross domestic product in 2009 to just 2.5 percent in 2014. Exports have declined almost 1 percent during the first seven months of 2015 compared with the previous year.
Signs are everywhere that the big red machine is slowing. Many basic industries, such as steel and cement, are operating at 75 percent capacity or less, and factory prices have been declining for three consecutive years. The government recently backed away from reigning in borrowing by local governments and has once again boosted infrastructure spending. The PBoC has cut interest rates four times since November.
The property sector, a critical source of growth, has also slowed, with housing prices in most major cities declining over the past year. After rising 150 percent in 18 months, the Chinese stock market has declined more than 30 percent, burning many small investors who were late to the game.
Slowest Growth in Two Decades
While the government hopes to reach 7 percent growth this year (assuming the headlines’ numbers are accurate), this would mark the slowest growth in two decades. Either way, look for Beijing to do anything necessary in the coming year in an attempt to bolster economic growth.
