Impact of China’s Weak Yuan on Emerging Market Currencies

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China Is Considering Weakening the Yuan to Balance U.S. Tariffs, Increasing Emerging Market Risks

China might be getting ready to make a big economic move that could have a big effect on world markets. In order to offset the economic effects of a possible 60% tariff on Chinese imports from the United States under President-elect Donald Trump, Chinese policymakers are reportedly considering allowing the yuan to depreciate considerably in 2025, according to Reuters reports.
As the nation deals with increasing economic pressures, this move marks a significant shift in Beijing's currency strategy. Trump's proposed tariffs, which would be 10% on all imports and a whopping 60% on Chinese goods, are thought to be the reason for the possible devaluation. In theory, a weaker yuan could reduce the cost of Chinese exports and lessen the negative effects of these tariffs, which would lessen their negative effects on China's economy. But there are significant risks associated with such a move.

A Two-Sided Sword: A Weaker Yuan

A depreciated yuan has the potential to cause a great deal of backlash even though it might help China keep its competitive advantage in export markets. It is anticipated that the People's Bank of China (PBOC) will protect the yuan in order to prevent Washington from taking severe retaliatory action. The central bank will probably put up a strong fight to keep the yuan from depreciating too much, according to Lynn Song, an analyst at ING.
PBOC-affiliated publications have made statements that have minimized the worries about currency weakness as part of Beijing's efforts to stabilize the yuan. The yuan is still stable, and forecasts indicate that it may even strengthen by the end of the year, according to Financial News. However, the situation is complicated by the larger economic backdrop.

China's Economic Challenges: A Recession in the Balance Sheet

Beyond trade disputes with the United States, China faces other economic difficulties. The nation is dealing with a number of internal problems, such as a collapsing housing market, a declining stock market, and slow consumer spending. According to Palinuro Capital's chief investment officer, Alfonso Peccatiello, China is experiencing a "balance sheet recession," in which businesses and consumers prioritize financial repair over investment or spending.
Traditional monetary policy instruments, such as interest rate reductions or currency devaluation, frequently fall short of stimulating the economy during a balance sheet recession. This is comparable to what happened to the eurozone during the debt crisis of 2011–2012, when austerity measures made monetary policy essentially useless. The loss of trillions of dollars in real estate-related wealth since 2021 has made it challenging for the economy to recover.

China's Slow Reaction and the Requirement for Fiscal Support

China's policy response has been mediocre so far, with modest fiscal stimulus plans not producing the expected outcomes. In order to increase liquidity, the government has also aggressively lowered interest rates and put in place measures to discourage short-selling in Chinese stocks. Analysts and investors are dubious, though, because these actions haven't done much to stabilize the economy.
A clear sign of the continued difficulties is the fact that the iShares MSCI China ETF, a crucial benchmark for Chinese stocks, is still almost 50% below its record highs from February 2021.

Why China's Issues Won't Be Solved by a Weaker Yuan

Although it may seem like a quick fix, economists do not believe that weakening the yuan will be effective. Peccatiello notes that lowering interest rates or devaluing the currency won't stimulate consumer or business spending during a balance sheet recession. The decline in wealth brought on by the collapsing real estate market and general economic uncertainty is the main problem, not the price of Chinese goods.
In other words, a weaker yuan won't rebuild the wealth lost in the real estate industry or give Chinese households and businesses their confidence back.

Targeted fiscal stimulus is the actual remedy.

Peccatiello contends that enacting significant, focused fiscal stimulus measures is the answer for China. Beijing could concentrate on giving struggling businesses and consumers direct assistance rather than implementing general, vague policies. Instead of depending only on currency devaluation, this focused strategy might aid in addressing the more profound structural problems the Chinese economy is currently facing.

Impact on the World: China's Economic Issues Spread Throughout Developing Markets

Emerging markets are already feeling the effects of China's declining currency. Particularly for nations with trade ties to China, the risk of capital flight and financial instability increases as the value of the yuan declines. Chinese exports are now more affordable due to the yuan's depreciation, which could undercut rivals in other developing nations. As a result, there is now a discernible relationship between China's exchange rate and other emerging-market currencies, underscoring the effects of China's economic difficulties on a global scale.
Analysts warn that these worries could lead to a recurrence of the 10%–15% depreciation that occurred during Trump's first term, further straining emerging markets. China can only let its currency depreciate so much, though, before it worsens capital flight and makes financial markets even more unstable.

Trump's Reaction: Higher Currency Devaluation Tariffs

The Trump administration has already made it clear that any attempt by China to manipulate its currency will not be welcomed. Trump's senior trade and manufacturing counselor, Peter Navarro, stressed that the White House would vigorously oppose any attempt by China to devalue the yuan. Although Trump plans to levy tariffs of up to 60% on Chinese imports, there is conjecture that he may take further action if China drastically devalues its currency.
The accusations have been refuted by China's embassy in Washington, which said that currency manipulation allegations are baseless and that the nation will not participate in competitive currency depreciation. However, with both sides bracing for a long-term economic conflict, the possibility of a trade war looms large.

In conclusion

The wider economic and geopolitical ramifications are becoming stronger as China considers devaluing the yuan to counteract the possible effects of US tariffs. A weakened yuan might provide Chinese exporters with some respite, but it won't solve the country's more serious structural problems, such the housing crisis and the balance sheet recession. Finally, in order to stabilize the economy and rebuild confidence, a more focused fiscal stimulus strategy might be required. In the meantime, China's economic policy will continue to have an impact on emerging markets worldwide, prompting concerns about the long-term ramifications of a possible trade war with the US.