Explaining the yuan's rout

SINGAPORE - On Aug 12 last year, a day after China announced a shock devaluation of its currency and called it a one-off thing, I wrote a piece in this newspaper under the headline: Expect More Yuan Slides.

The reasoning was simple: China had been dipping its vast forex treasure trove to shore up the currency, was only holding back from further cuts as it sought reserve currency status with the International Monetary Fund and was facing unprecedented headwinds on the trade front.

More tellingly, capital flight was being evidenced in myriad ways, even as the government foreign exchange regulator claimed that there had been "no large and continued capital flight so far".

All this, plus the efforts to put a floor under cascading share prices was costing the government dearly, and winding down the impressive reserves, which, at one point, amounted to some US$4 trillion. Clearly, it was not a sustainable situation.

"China's economic managers, generally known for their sagacity," I wrote, "have been signalling panic lately." The devaluation move had that element.

Now, the chickens have come home to roost. China's currency has consistently been guided lower since it managed to get the IMF to include the yuan in its basket of currencies for the Special Drawing Rights. Indeed, it has fallen on every trading day of the New Year.

This is on account of two factors: As I wrote in August, fear that the slowdown in the broader economy is worse than let on is a key reason. The other is that China's economic managers are not on top of the situation. Indeed, since we know now that even China is not immune from economic cycles, the second point is the bigger worry. The decision to suspend the share market's short-circuit mechanism two days after it was introduced suggests a knee-jerk response that buttresses the point. Pitifully, rather like former Malaysian Prime Minister Mahathir Mohamad at the height of the Asian financial flu in September 1998, the PBOC has blamed "speculative forces trying to reap gains" for the currency's fall.

China's steep devaluation in 1994 hurt the exports of the rest of Asia and was partly responsible for the Asian flu that started with the Thai baht's crash in July 1997. It then won enormous goodwill by not taking further steps to devalue, when the rest of East Asia was suffering mightily. But times have changed. The rundown of its reserves is becoming intolerable, and could even affect its strategic goals such as the OBOR project. Manufacturing is seeing job losses-- this week, reports appeared that a provincial government had offered Foxconn what amounts to a subsidy to retain jobs that are being shed as Apple iPhone orders shrink.

China is not seeking to beggar its Asian neighbours but only trying to save itself. The devaluation is not so much aimed at improving the competitiveness of its exports vis a vis East Asia, but with an eye to Europe, where manufacturing across the Eurozone has been expanding on the back of an easing euro. China, in the past decade, has handily passed Japan as the top exporter of high-end engineering goods. These compete with the goods sent out of industrial powers such as Germany and France.

The fallout from China will have to be managed carefully. It is time for regional central banks to have a deep conversation with their financial industry stalwarts and prepare for the reverberations that will inevitably follow.