Opinionista Thembani Mbadlanyana 4 September 2015

Should the world dance or sing along to China’s currency devaluation song?

The question of whether the world should dance or sing along to the currency devaluation song China is singing is neither here nor there. Given China's importance in the evolving world economic order and to global financial stability, what is material here is the need to develop more reliable and less politically biased empirical explorations of China's decision to compose its hit song. Equally important should be the realisation that China's development decisions are important for Africa — hence it is imperative that African vibes are also factored into our attempts to comprehensively understand the different notes that make up the Chinese hit song.

On 11 August 2015, the world woke up to the news of the yuan’s devaluation. Though the Chinese currency was initially devalued by about 2% – over the ensuing days it plummeted by some 4% against the dollar. This move did not only leave many global markets actors dumbfounded, it also earned the yuan’s devaluation a new status as la chanson du jour – the world’s metaphorical song of the day , one that played different tunes to different people’s ears. Various interpretations of the same song have since permeated every corner of global markets – with no clarity on whether the world should dance or sing along to the currency devaluation song.

Notwithstanding the buffet of intellectual ideas on and interpretations of the song, at a very general and tentative level, it seems logical constructions for contextualising and explaining transnational concerns around the song have been strictly couched in the success-failure binary or boxed into the good-bad dichotomy. Many analysts have either focused solely on discernible ‘out of tune vibes’ (negative upshots) in the song and how those might affect the evolving world economic order and global economic growth; or squarely on good rhythmic ambiances (positive spill-over effects) imbued in the song and how those might spread to China’s economy and those of its trading partners. To this end, questions arise as to whether dichotomising the song is the most productive thing to do. Whether there is need to de-dichotomise the debates around the song, and in so doing, produce a remix of the song that eschews both narrowly pessimistic and overly ‘romanticised’ views of the song to favour, instead, a balanced and careful analysis that is mindful of the interwoven social, economic and political dynamics that gave rise to it.

For some time now, China has been at the forefront of global economic growth. In fact, as noted by two leading trade and economic policy experts, Eswar Prasad and Thomas Rumbaugh, China has not only changed the co-ordinates of the global economy, it has also heralded tectonic shifts in production, trade, and investment patterns across the world – ending up as the locomotive of global economic growth. Though seen by others as a Johnny-Come-Lately to global markets, with a delayed integration into the broader global economy, in a relatively short period of time, China has made its presence felt. It has been punching above its weight and in the process, has ended up earning the economic clout much needed in global geo-politics. World Bank lead economist Punam Chuhan-Pole recently revealed that, as the second largest economy in the world and a powerful economic force to be reckoned with, China’s demand for commodities has been increasing at an unusually fast pace for its level of income per capita. And until recently, its consumption of agricultural crops and base metals accounted for 23% and 40% of global production, respectively.

But, notwithstanding the recent promising economic trajectory characterised by sustained growth, according to the 2015 International Monetary Fund World economic Outlook, China’s growth fell to 7.4% in 2014 and was expected to fall further to 6.8% in 2015. Moreover, in terms of the 2015 Organisation for Economic Cooperation and Development economic forecast for China, Chinese growth is projected to continue to edge down, to 6.7% by 2016. Brookings Institute senior fellow Amadou Sy points out that China’s gross domestic product (GDP) official growth rate has dropped to 7% from a double-digit average in 2010. If statistics are anything to go by, it seems China’s potential economic slowdown is the real issue. An unavoidable question then is, why is this so?

There is no simple answer to that question. In a more analytical vein, it seems the sluggish growth rate might have occasioned the economic slowdown and the subsequent composition and release of the now infamous Chinese hit single (currency devaluation). Another fundamental factor that is seen by many analysts as woven into Chinese maestros’ (policy makers’) decision to compose this song is the investment-driven nature of the country’s economic growth. According to Liang Xiaomin, a professor at Beijing’s Tsinghua University, “large-scale investment has long been the driving force behind China’ economic rise, accounting for about 50% of growth over the past three decades”. Xiaomin contends that, in 2012, about 13 Chinese provinces initiated investment projects, amounting to 12.8-trillion yuan ($2.05-trillion) and the effect of these projects was noticeable in China’s growth rate (7.4%) in the third quarter of 2012. This raised the hopes of the central government that it would achieve its annual growth rate target of 7.5% in 2012. As Martin Wolf pointed out recently, at some point, gross fixed investment was 44% of GDP.

According to Xiaomin, “such a growth model was an obvious choice as China transitioned from an agricultural to an industrialised country”. In order to boost the growth rate, the Chinese government heavily invested in a number of infrastructure projects at home and abroad. But though a great idea initially, without transforming and innovatively upgrading the economy, investment-driven growth (accompanied by high pollution and low salary levels) might have, in part, contributed to China’s economic woes, including the downward growth rate. As a result of that heavy investment and the recent slowing growth, China had to grapple with a plethora of challenges on the economic front. What the Chinese economic policy wonks did not realise was that the decision to use investment to boost the economy had its limitations and was not far from being counter-productive. Focusing on investment-led growth was doing a disservice to consumption-boosting efforts and in the long run, it was not going to be sustainable or perpetually yield the desired outcomes.

Informed by the above and convinced of the necessity to rebalance and reorder the country’s evolving economic architecture and change drivers of economic growth, Chinese maestros conceived the currency devaluation song. At first glance, given the challenges in addressing low demand, the plan was to slightly move away from an investment-led economy to one dominated by consumption, while sustaining aggregate demand. One way of doing this was by intervening through monetary policy and/or direct exchange rate intervention (devaluing the currency) – a policy shift designed to make the currency more market responsive and competitive in global markets. It was hoped that, through monetary stimulus; a weaker yuan would make Chinese exports cheaper and more competitive – thus increasing demand, boosting the money supply and keeping the Chinese manufacturing and other sectors busy.

Now, as we take stock of China’s move to release its hit single (currency devaluation), it seems the economic punditry is divided on its immediate and long-term effects. According to the experts from the Brookings Institute, a 2% or 4% drop in a currency is not that large, especially when compared to the movements of floating currencies. For instance, according to Sy: “The US dollar has appreciated by about 20% relative to the euro and the yen, and the South African rand has dropped by about 12% against the US dollar this year.” But a contrary view expressed by some observers is that a weaker yuan might be a positive thing for the country’s growth figures in the short-term since it might help boost the economy, but in the long run it could actually make it more difficult for Beijing to make the transitions it needs to in the years and decades ahead. More importantly, the move by the Chinese to devalue their currency extends beyond China’s immediate economic boundaries and arguably, one of the implications for such a move could be that, trade or export growth of other key economies could be badly affected. For instance, a weaker yuan could damage a number of multinational firms because their goods become more expensive in China. Companies that often complete their business transactions in China (such as Apple) could be among the hardest hit in the markets. Foreign multinationals would have to put up with low-cost Chinese products. What this also entails is that Chinese goods could be cheaper in other countries, thus creating more competition for local businesses. As such, economic experts like the governor of the Reserve Bank of India have cautioned that moves taken by countries whereby they devalue currencies due to low demand, can lead to a “free for all” on the global stage.

Perhaps, it is still too early to make definite judgments on the Chinese currency devaluation song. But then again, at first glance, it seems that the devaluation has raised more fears than hopes. While market analysts are reflecting on the implications of the devaluation on global markets, it can still be argued with a degree of certainty that the song has given rise to a number of concerns and questions. This is evinced by the fact that there was an upheaval in global financial markets following the devaluation of the Chinese currency. Global markets continued to take a knock after Beijing devalued its currency and this gave rise to renewed concerns about a stronger-than-anticipated slowdown of the Chinese economy and possible currency wars. Reserve Bank of India (RBI) governor Raghuram Rajan opined that China’s currency devaluation was giving rise to a number of legitimate concerns and was propelling fears that the global economy is more fragile than it appears. For Rajan, China’s move to devalue its currency and protect its stock markets not only represented a “worrisome trend”, it also gave rise to questions about the “true strength” of the world’s second largest economy.

Having listened to Mozart’s Die Entführung aus dem Serail, the Austrian Emperor Joseph II concluded: “Too beautiful for our ears and far too many notes, dear Mozart.” It can be debated ad infinitum whether Chinese maestros (economic policy makers) have become latter-day Mozarts by infusing too many notes into their currency devaluation song. It is not clear whether the song is easy or heavy on the ear and whether or not the world should dance or sing along to it. Seemingly, whether the song is good or bad is amenable to different interpretations.

But be that as it may, the song cannot be complete without the infusion of some African tunes. In fact, notwithstanding the possibility of messing up the song with too many notes, one can’t resist the temptation of imbuing it with some African tunes. This temptation arises out of the realisation that China remains Africa’s largest development and bilateral trading partner – hence one can’t wait to join the global economic choristers as they sing these yuan devaluation blues. According to Professor Deborah Brautigam from Johns Hopkins University, trade between Africa and China skyrocketed to $220-billion in 2014, nearly three times the US level.

As such, even though Sy characterised the Chinese currency devaluation decisions as just a tremor, not a quake, it is imperative to ask questions such as: What is the Chinese move likely to mean for Africa? Should it be a real concern for Africa? Will it have a negative impact and exert undue pressure on African economies? Given the vulnerability of many African markets and industries, will local businesses be able to compete with cheap Chinese exports? For Sy, the Chinese yuan devaluation should not be a concern for Africa, but a weakened Chinese economy is. In reality, is this the case? Will African economies benefit from the yuan’s devaluation?

A report by two International Monetary Fund economists, Paulo Drummond and Estelle Liu, focusing on the impact of changes in China’s investment growth on sub-Saharan African exports, found that China affects the region’s economies directly through its exports and indirectly through commodity price effects, and through the international prices of manufacturing products. Drummond and Liu found that “a one percentage point decline in China’s investment growth is associated with an average 0.6 percentage point decline in sub-Saharan Africa’s export growth”. The effect is profound for resource-rich countries with a large share of the region’s exports going to China.

According to Brautigam, in the short term it is hard to see how currency devaluation can help or hurt Africa, notably its productive and export sectors. Giving credence to the linkages Drummond and Liu alluded to, Brautigam argues that if China bounces back and continue on a positive economic growth trajectory, Africans will benefit. According to her, when viewed from another perspective, China’s African investments will be helped because, with the devaluation, “Chinese investors will see their profits from African investments automatically rise (in yuan terms) and this could lead them to expand”.

As Brautigam points out, Chinese companies have become major foreign investors in different African countries and this augurs well for African growth and development – more especially since China’s growing reserves were recycled into large loans for infrastructure finance across Africa. The large presence of Chinese investors in Africa and resultant increase in Chinese demand for African commodities has been at the centre of a long period of sustained African growth. According to experts from Brookings Institute, some African countries — such as Ethiopia, Kenya and Mozambique — may benefit from the cheaper cost of Chinese goods they import, such as Chinese-made heavy machinery, bulldozers and electrical lines. Besides the positive trickle down effects for large industries and big businesses, some analysts are of the view that African retailers and consumers will also have access to low-cost Chinese goods.

But there seems to be an acknowledgement that, on the flip side of the same coin, there can be some few negative upshots. By the same token, Sy posits that, with the devaluation of the currency, new Chinese investors might find that they have to pay more (in yuan) to buy dollars for overseas investments. Brautigam seems to be singing the same negative tune as Sy when arguing that low wages in African countries that have been attracting huge factory investment from China will no longer be a pull factor. Instead, with costs now relatively lower in China, the push to relocate factories overseas will slow. Though this might put China at an advantage, for Africa it might have adverse ramifications and possibly, as Brautigam rightfully observes, it might “postpone Africa’s own structural transformation”.

In addition, on the down side, African manufacturing sector might suffer from a competition with cheap Chinese imports. Meanwhile, African exports may become more expensive in China, leading to a substantial drop in export revenues. Furthermore, while other manufacturers who use steel in their products might benefit, lower cost steel imported from China might hurt major African steel producers. Another casualty of the devaluation of the yuan might be the tourism industry because Chinese tourists will be more likely to vacation at home as African safaris become relatively more expensive.

All in all, having explored the complexities and uncertainties of the Chinese devaluation song, it seems the question of whether the world should dance or sing along to it is neither here nor there. Given China’s importance in the evolving world economic order and to global financial stability, what is material here is the need to develop more reliable and less politically biased empirical explorations of China’s decision to compose its hit song. Equally important should be the realisation that China’s development decisions are important for Africa — hence it is imperative that African vibes are also factored into our attempts to comprehensively understand the different notes that make up the Chinese hit song.

Moving forward, there is a need, not only by Africans but by all economic policy makers in the global south, to try to understand monetary and fiscal policy decisions taken by Beijing because the recovery and resilience of the Chinese economy is fundamental not only to the economic futures of the developing countries and global financial stability, but also to the transformation and/or reform of the global financial architecture. DM