One side effect of trying to boost a nation’s economy is currency depreciation. However, in China they must do so without allowing the yuan’s value on the foreign exchange market to change. Especially after exports unexpectedly fell 3.3 percent in January, China cannot afford to allow its currency to appreciate. This would have two negative effects on the economy. First, it would diminish the effect of China’s stimulus, which would be troublesome for leaders attempting to counter the lowest GDP growth rate in 24 years. Second, it would make exports less competitive on the global market, which would also diminish growth in 2015 by further decreasing net exports.
On the other hand, depreciation of the yuan will also be problematic. The Bank for International Settlements, is owed $1.1 trillion by various Chinese companies. This means that any decrease in the value of the yuan will make it harder for these loans to be paid back, putting additional stress on companies amid an economic slowdown. In addition, depreciation would devalue loan payments by countries such as the US whose debt is owned mostly by China.
In order to walk this “tightrope” the PBoC has a few tools at its disposal. To help the economy, it recently cut interest rates and reduced the amount that banks need to keep in their reserves for the first time in two years. If these inflationary policies have their intended effects and depreciate the yuan as a result, the PBoC also has $3.8 trillion worth of foreign currency reserves to counter any such change in the yuan. In sum, China faces a distinct challenge not faced by other nations by attempting to increase the rate of GDP growth without affecting its currency’s value relative to the dollar.
http://www.bloomberg.com/news/articles/2015-02-16/china-s-1-trillion-reasons-to-prevent-yuan-tumbling-currencies
It will be interesting to see how the yuan fairs as the PBoC liberalizes its monetary policy abroad. The introduction of another Chinese currency trading hub in Canada will place offshore yuan further at the behest of FOREX traders. This seems like a departure from the past PBoC that strictly manipulated the yuan to be artificially low in order to attract foreign companies to produce in/import from China. I wonder if PBoC will settle on one side of the “tightrope”: either maintain the quasi-fixed exchange rate to drive growth or transition into a floating currency to fit with their maturing economy. Or maybe stick with a combination of the two.
I’ve not heard before of significant US$ borrowings by Chinese companies. Whether the exchange rate matters for that is a function of what the borrowing was for. If it was cross-currency borrowing because firms couldn’t raise money in China, or because they used it as a bet on additional yuan depreciation, then it certainly matters. However, the depreciation to date is from 6.05 to 6.25 or about 0.2/6 = 3.3%. It is less or nil for currencies such as the yen and euro, that have depreciated against the dollar by more than that — the BIS is likely consolidating all foreign currency borrowings in that US$-denominated estimate. That is, so far it doesn’t matter much.
Now if the borrowing was to finance petroleum exploration and other direct foreign investment, then the revenue that would be used to repay loans is in US$. In that case, there’s no foreign exchange risk: whether the yuan is weak or strong is irrelevant. For FDI there is in contrast normal commercial economic and political risk. For example, a loan to investment in a mine made at the peak of commodity prices may be a bad loan under any scenario. Similarly, political risks are high for some African resource projects, where a coup d’état can render assets valueless.