2017 began with the theme of yuan depreciation. The People’s Bank of China revised its currency basket, which it uses to determine the fixing, or central rate, of its currency, which determines the level of its interventions in the foreign exchange market. This basket initially included 13 currencies, compared with 24 today. The weighting of the euro has fallen from 5.1% to 16.3%, the US dollar has lost 4% to 22.4% in the new basket, while the yen has lost 3.2% and now accounts for only 11.5%. Among the main new currencies, the Korean currency now accounts for 10.8%—the fourth currency for China—far ahead of the Saudi riyal (2.0%), the United Arab Emirates dirham (1.9%), and the South African rand (1.8%). The People’s Bank of China (PBoC) is thus promoting a depreciation of the yuan through purchases of foreign currencies financed by foreign exchange reserves. These reserves have fallen by US$1 trillion in 18 months to just over US$3 trillion in December 2016.
Emerging countries, particularly those in Asia, are thus facing three risks.
The first risk is the continued depreciation of the yuan, which improves the price competitiveness of the Chinese economy but undermines the relative advantage of other Asian countries that export similar goods. Their commercial attractiveness on the global market would then decline.
The second risk is the continued strengthening of the US dollar, which would further increase the burden of dollar-denominated debt for these same countries and limit their ability to finance a competitiveness deficit through debt leverage. This is the case in Indonesia, where 52% of non-financial corporate debt is denominated in US dollars, and in the Philippines, where 80% of external debt is denominated in US dollars.
The third risk is a depreciation of the yuan, which would reflect a slowdown in Chinese demand and therefore a slowdown in external markets for countries dependent on this trading partner. This is the case for Taiwan, Hong Kong, Thailand, South Korea, and Indonesia. In addition, the depreciation of the yuan was stronger than the appreciation of the US dollar in December, which can be explained by a weakening of the balance of payments, with both the trade balance and the current account slowing down. The contraction in foreign direct investment, capital outflows, and lower reserve accumulation are also contributing negatively to this balance. This trend is expected to continue in 2017. More specifically, the trade balance, including petroleum products, is expected to accelerate its deficit due to the appreciation of the price of oil.
In short, the current market configuration shows a positive correlation between the US dollar and the price of oil. A stronger US dollar weighs on emerging economies, whose growth is significantly financed by US dollar debt leverage. The rise in oil prices improves the activity of net oil-exporting countries. However, the yuan is set to depreciate with the strengthening of the US dollar, but also with the appreciation of oil prices, which is weighing negatively on its trade balance. Being selective among emerging markets requires finding economies that are less competitive than China, less financed in US dollars, but with a trade balance that would benefit from higher oil prices.
