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Echoes Of 1997: China Devaluation "Rekindles" Asian Crisis Memories, BofA Warns

In "Currency Carnage: Gross Warns On 'Fakers And Breakers'; Morgan Stanley Tells Asia To Watch Its REER," we outlined which Asia ex-Japan economies faced the biggest risk from China’s decision to devalue the yuan. 

Broadly speaking, a weaker yuan will likely cause regional economies to suffer a loss of export competitiveness in combination with decreased demand for their products on the mainland.

Even before the latest shot across the bow in the escalating global currency wars, EM FX was beset by falling commodity prices, stumbling Chinese demand, and a looming Fed hike.

Now, the situation is immeasurably worse.

We got a preview of what is perhaps in store when, on Tuesday, Indonesia reported that trade had collapsed in July, while Friday’s meltdown in the ringgit as well as Malaysian stocks and bonds underscored just how fragile the situation has become. And while, as Barclays notes, "estimating the global effects China has via the exchange rate and growth remains a rough exercise," more than a few observers believe the effect may be to spark a Asian Financial Crisis redux.

For their part, BofAML has endeavored to compare last week’s move to the 1994 renminbi devaluation, on the way to drawing comparisons between what happened in 1997 and what may unfold in the months ahead. 

"On 1 Jan 1994, China unified its exchange rate by bringing the official in line with swap market rate, devaluing the RMB official rate by nearly 50% (from 5.8 to 8.7 RMB/USD)," BofA reminds us, adding that because only a fifth of transactions occurred at the official rate, the effect was a devaluation on the order of 7%. Because the bank (and they aren’t alone here) ultimately sees the yuan weakening by 10% against the dollar this time around, "the magnitude of devaluation [will] effectively be larger than the 1994 move."

As for the fallout, BofA is "concerned about the competitive impact from China’s devaluation on rest of Asia, as the devaluation comes on top of [1] China’s deflation; [2] China’s growing market share in key third markets; and [3] Asia’s sluggish exports." As the following charts and subsequent commentary make clear, China was already taking share and now, that dynamic could accelerate and demand, already depressed, could be reduced further by the weaker yuan: 

China’s market share of US and EU’s imports was already expanding, pre- devaluation (Chart 5 & Chart 6). China was already eating into rest of Asia’s market share, even with an anchored RMB. China’s market share of both US and Europe’s imports generally rose strongly from 2000 – 2010, before moderating during the GFC but has since picked up. China now accounts for about 20% of US imports and 7% of Europe’s imports. In contrast, ASEAN’s share of US imports has declined to 4.4% over 2011-14 from 7% in 2000, before recovering to about 5% in the first half of this year.

 

 

In Europe, ASEAN’s share has declined to about 1.8% in 2008 from 2.6% in 2000, before picking up to about 2.4% this year. The IMF Regional Outlook also highlights that China, a major player in Asian supply chains, is capturing an increasingly larger part of the chain as domestically sourced intermediates (from either locally owned producers or subsidiaries of foreign firms) increasingly replaced imported intermediate goods. China’s “on-shoring” is thus one more reason why rest of Asia’s exports is struggling.

 

Northeast Asia economies will likely face greater competitive pressures from China’s devaluation given stronger trade linkages and overlapping exports. Trade links with China are highest for the Northeast Asian economies: Taiwan (16% of GDP) and Korea (10%). More than a quarter of exports from Korea and Taiwan are destined for China. China’s lower tech exports also compete more closely with Korea and Taiwan. Almost a fifth of Japan’s exports are for China. For Southeast Asia, only 10% of exports go to China, with Malaysia and Singapore having a larger share. But ASEAN commodity exporters (Indo, Mal and Thai) will also be hit if China’s devaluation reduces import demand and intensifies the deflationary pressures on commodity prices.

BofAML's conclusion is that China's devaluation has added "another layer of risk and uncertainty for the rest of Asia, on top of the looming Fed funds rate hike cycle."

"Asia," the bank's FX strategy team continues, "is already not in a good place (compared to past Fed rate hike episodes), as exports are contracting, domestic demand is sluggish and monetary policy is out of sync with the Fed," which means that between the weaker RMB and a Fed that will eventually have to try and prove that contrary to what the St. Louis Fed's Stephen Williamson says, an exit from ZIRP is actually possible, a 1997 replay may indeed be in the cards.