The Yuan’s devaluation has made investors nervous

GS-II: The Yuan’s devaluation has made investors nervous

CONTEXT

Chinese yuan broke the seven-to-one parity against the dollar for the first time since 2008. China deliberately devalued the Chinese currency after the latest tariff threats issued by US.

Why China did do this?

Economic reasons

China’s weakening manufacturing competitiveness is likely to strengthen with yuan-priced goods and services getting cheaper across supply chains in East Asia, parts of Africa, etc.
It is likely to widen China’s trade surplus with the US in the immediate short run.
It will also help China expand trade margins within its own region, especially with Vietnam, Thailand, Indonesia, etc.

Political Reasons

The US’ own strategic engagement in Asia has weakened under Trump, who questioned the “value of US alliances with Japan and South Korea
Japanese imposed trade restrictions on South Korea. China and Russia staged their first joint aerial patrols in the region, causing South Koreans to react militarily.
China-US friction has offered significant economic and political leverage to smaller emerging nations like Vietnam and Indonesia within their respective regional spaces.

Problems

Risk not only for those trading in the US and Chinese currencies or their stocks but also for capital flows between emerging markets
China, around 2015-16, tried something similar by letting the yuan depreciate; it led to a stock market crash in China, and billions of its dollar reserves disappeared in just a few days.
That devaluation saw led to a massive capital flight from China, further weakening its external position.
The debt denominated in foreign currencies has increased for global companies and developing nations across the world and may be vulnerable to a currency shock if the “currency war” continues.
Most foreign investors switched to the safety of gold or other currencies like the yen.
China’s weakening of its currency to hurt US economic interests for political gains will only make other Asian countries more vulnerable to a political crisis that could quickly escalate to a financial crisis

Source: Live Mint

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