The Yuan Devaluation and Its Impact on Hong Kong

August 20, 2015 Updated: August 21, 2015

Following China’s stock market crash in mid-June, the devaluation of the Chinese yuan early last week sent another shock wave through the global markets as the People’s Bank of China lowered the daily reference rate for the yuan by nearly 2 percent on Aug. 12.

The yuan continued its slide for the next 2 days and only began to stabilize on Friday.

In the past decade or so, China has often been criticized, particularly by the United States, for undervaluing the yuan through exchange rate manipulation. In response to this, Chinese authorities have allowed the yuan to appreciate gradually.

The exchange rate of the yuan against the greenback has risen by some 25 percent in the past 10 years. On the other hand, the strengthening of the US dollar in recent years against other currencies means that the yuan has appreciated along with its US counterpart, thus resulting in a loss of export competitiveness for Chinese goods.

Over the past year, the yuan has gained more than 20 percent against the currencies of some major trading partners such as Japan, Australia, and Malaysia. It is therefore no surprise that China’s export growth in July tumbled 8.3 percent year-on-year, the weakest reading since February 2014.

Undoubtedly, the devaluation of the yuan is an attempt by the Chinese authorities to boost its exports and to hit its 7 percent annual growth target. But the hard truth is that a devaluation of such magnitude is unlikely to produce any significant impacts on the real economy.

Some analysts argue that to achieve any substantial results, the yuan needs to devalue by at least 10 percent. Given the strong market reactions, it is expected that the Chinese authorities would need to adopt a very cautious stance, and further devaluation of the yuan in the near future seems like an untenable policy alternative.

The Hong Kong stock market reacted negatively, with the Hang Seng Index losing some 500 points in the 3 trading days following the devaluation. As the largest offshore center for the yuan, the territory is sure to be significantly impacted by the devaluation.

For instance, investors in yuan bank deposits, which have gained great popularity over the years, would be among those suffering. It is estimated that the devaluation has almost wiped out the average 3 percent annual return on these deposits. There are already some signs of capital flight.

Unless the Chinese authorities can manage to restore market confidence, investors will become much more wary when it comes to putting their money into yuan-denominated instruments, possibly leading to slowing down the internationalization of the yuan as well as weakening the outlook of the Chinese economy.

This could in turn affect the new listing of Chinese enterprises on the local market and impede Hong Kong’s continual development as a major financial center in the region.

In addition, the devaluation might lead to a further decline of mainland Chinese visitors to the territory, hurting the already battered retail sector.

One piece of good news may be that the burden of the grassroots can be eased somewhat with the lowering of prices of imported goods from China, including staple foodstuffs and other household items.