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NEW DELHI: Amidst increasing geopolitical tensions, there is growing speculation that China may be considering a drastic economic maneuver—devaluing its currency, a move often referred to by economists as the “nuclear option” due to its potential widespread global impact.

Andreas Steno Larsen, CEO of Steno Research, raised concerns last week about China’s intentions following its aggressive acquisition of global commodities. “China is preparing for something major. That seems increasingly obvious judging from the stockpiling of important resources. Could it be that they are preparing a major one-off devaluation of the CNY?” Larsen wrote.

Currency devaluation could theoretically boost Chinese exports by making its goods cheaper and more competitive internationally. However, such a move could also lead to significant global economic disruptions, including exacerbating trade tensions with major partners like the United States, a Newsweek report said.

China has been bolstering its reserves of gold and crude oil, actions that could potentially provide a buffer against the economic fallout from a currency devaluation. The country’s central bank has been on a gold-buying spree, continuing to increase its reserves of the metal for the 17th consecutive month despite high prices and a weakening yuan.

Eswar Prasad, a professor at Cornell University and former International Monetary Fund official, highlighted China’s strategic motives, “Official gold purchases reflect a desire to diversify foreign exchange reserves away from the dollar and other Western currencies,” Prasad explained to Newsweek. This diversification is seen as a protective measure in the face of escalating geopolitical tensions, particularly with the US, and economic vulnerabilities exposed by the sanctions against Russia following its invasion of Ukraine.

Furthermore, there are concerns that China’s resource accumulation could be in preparation for more than just economic warfare. Speculations arise that Beijing might be bracing for the international backlash that could result from a potential military confrontation over Taiwan. Michael Studeman, former head of the Office of Naval Intelligence, suggested that China is taking protective measures to safeguard its economy against possible future sanctions. “Xi seems to have studied the sanctions playbook the West used against Russia over Ukraine and subsequently initiated long-lead protective measures to batten down the hatches of China’s economy to resist similar pressure,” Studeman wrote in a recent op-ed.

While some analysts, like Craig Shapiro, macro adviser to LaDucTrading, believe that China is unlikely to devalue its currency directly against the dollar, the ongoing purchases of commodities in renminbi from sanctioned producers like Russia and Iran indicate a strategic positioning. Shapiro noted, “China’s ability to buy commodities in RMB and settle excess trade balances in gold with countries like Russia, and those in OPEC, suggests that the gold buys more commodities in China than it does in the West.”

A currency devaluation by China could have significant implications, both domestically and globally:
Boost in export competitiveness: By devaluing its currency, the yuan, China could make its exports cheaper and more attractive on the international market. This would potentially increase sales abroad, benefitting Chinese manufacturers and bolstering the national economy, particularly in sectors that rely heavily on exports.
Inflationary pressures: For the domestic economy, a devaluation could lead to higher import costs, particularly for commodities and intermediate goods priced in foreign currencies. This could cause inflation to rise, affecting the cost of living for Chinese consumers and potentially leading to social and economic tensions within the country.

Global trade relations: A sudden devaluation of the yuan might exacerbate trade tensions with major trading partners, particularly the United States, which has previously accused China of manipulating its currency to gain unfair competitive advantages. This could lead to retaliatory measures, including tariffs and other trade barriers, further straining international relations.

Impact on global markets: The international financial markets could see increased volatility as traders and investors react to the devaluation. This could affect currency, bond, and stock markets globally, particularly in emerging markets that are sensitive to changes in risk sentiment.

Debt servicing challenges: For Chinese companies with debt denominated in foreign currencies, a weaker yuan would increase the cost of servicing this debt. This could lead to financial difficulties for companies that are heavily leveraged externally.

Foreign investment flows: A weaker yuan could impact foreign investment in China. While lower operating costs might attract more foreign companies, concerns about further devaluation and instability might deter long-term investments.

Economic contagion: Given China’s significant role in the global economy, a devaluation could lead to economic contagion, affecting economies with close trade ties to China. Countries dependent on exports to China might find their trade balances impacted, while global supply chains could also experience disruptions.

  • Published On May 1, 2024 at 03:39 PM IST

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