China’s surprise move in devaluing the yuan could a calculated way to free up the currency and get it ready for a bigger role internationally, experts say. On the downside, it will have an impact on corporate earnings when it comes to translating yuan into dollars. That’s because a strong dollar, already an earnings downer this year for corporations with lots of business in China, will now be much more potent.
In its release, the People’s Bank of China said the devaluation will be “one-off.” Global markets sold off amid fears China’s economy was weakening further and authorities were just trying to arrest that weakness. However, many observers say the move was among other things, a strategic play to get approval of the International Monetary Fund to get Special Drawing Rights status for the RMB.
The IMF this year conducts its twice-a-decade review of SDR, which is an international reserve asset based on a basket of four major international currencies: the dollar, euro, pound and yen. The IMF will finish its review by the end of the year and there has been speculation the IMF, based on the growth of the RMB so far, will add it to the basket.
But according to a note from Standard Chartered, an interim report from the IMF recently “raised questions over the CNY being sufficiently ‘freely usable’.”
“The IMF report said the USD-CNY fix should be a market-based representative rate, implying spot/fix convergence,” Standard Chartered said. “Second, for the offshore CNY (CNH) market to be counted as a valid hedging market, there should be much greater CNY-CNH spot convergence. Full convertibility is not required for SDR, but being ‘freely usable’ is.”
Win Thin, Global Head of Emerging Market Currency Strategy at Brown Brothers Harriman, said in a note to clients that China wants to “give the market a bigger role” and that eventually, “we think that policymakers would like to eliminate the daily fix altogether, and to unify and onshore and offshore exchange rates.”
Mr. Thin also doesn’t think the devaluation will have any impact on the RMB’s internationalization efforts. “We believe the IMF will look favorably on this attempt to allow for greater market forces in determining the exchange rate,” Mr. Thin said.
Indeed, if the result of this move is eventual SDR status, it will give the currency’s internationalization prospects a hefty boost. That’s because central banks would become holders of RMB exposure through their SDR assets. This official recognition of the RMB’s reserve currency status would likely then spur RMB investment by central banks all over the world, particularly those in developing countries looking to hold yuan assets and diversify away from dollars. Inclusion could propel the RMB past sterling and yen in usage.
“Inclusion into the SDR basket is not a done deal, but cautious official comments suggest that it will happen once the IMF’s concerns are met,” Mr. Thin said. “China has already adopted stricter norms for transparency its debt and foreign reserves data, and it will continue to along this path in the coming months ahead of the September 2016 SDR decision by the IMF.”
For multinationals with a lot of sales in China, the devaluation’s effects will linger. The strong dollar over the past several quarters has already hit earnings of the likes of Pfizer, DuPont, P&G, and Caterpillar among many others. Now a weaker yuan exacerbates this situation, meaning less revenue when the currency is translated back into US dollars.