The move by the Chinese authorities to allow the renmimbi to devalue somewhat against other currencies this week is an important signal, even if its motives for doing so are debatable. The signs are that the Chinese economy has experienced a slowdown from the strong growth rates of recent years, leading to speculation that the currency was being allowed to weaken to boost exports. However, the extent of the currency decline so far would have a very limited impact and so close attention will now be paid to whether it is allowed to drift lower in the months ahead.
The Chinese central bank changed the way it set the daily mid-point for trading in the renmimbi during the week, but later appeared to ensure that the currency did not drop too far. It is thus unclear whether it is, in fact, trying to engineer a depreciation or is moving to allow its currency value to be more determined by the market. The latter move might encourage the IMF to accept the renmimbi as one of the major currencies used to calculate the value of its so-called special drawing rights (SDR), its international reserve asset.
On the other hand, attempts to engineer a so-called competitive devaluation could lead to tensions with the US and other major countries. Time will tell, though the weakening of the Chinese economy may, indeed, justify a lower currency value. Perhaps the more fundamental issue highlighted by the week’s development are this growth slowdown. Official data remains generally upbeat, but there are clear signs of slowing exports and reports from across China of businesses running below full capacity. Meanwhile the demand from China itself which had been expected to boost global demands does not seem to have emerged – one reason why the price of everything from oil, to iron ore, to milk remains low.
For the international economy, higher growth in the UK and US may take up some of the slack from a Chinese slowdown. However, both these economies are mulling over how and when to start increasing interest rates, another part of the reason for uncertainty internationally and pressure on emerging markets. Meanwhile recovery remains painfully slow in Europe.
A persistent fall in the renmimbi, if that is what emerges, would only make it harder for the big western economies to emerge convincingly from deflation. It could mean that interest rates stay lower for longer as world central banks battle the tricky problem of stagnant prices.
Meanwhile, we must hope that the Chinese authorities provide more clarity on the position of their economy and what they plan to do. China is a critical component now of the international economy and increasingly more integrated into it. While much attention has been focused on Greece in recent months, what happens in China is likely to have a more significant impact on the economic outlook.