The Chinese yuan's sharp plunge this week, after the People's Bank of China widened the trading band, has led to understandable nervousness in the markets. Regional currencies, especially of nations that do not have vast foreign exchange reserves to protect them, are going weak at the knees. In various ways, Malaysia, South Korea, Thailand and Taiwan, not to mention Hong Kong, whose dollar is pegged to the greenback, are poised to bear the brunt of the yuan's drop - a weakening that may not have ended. China's reference to a "one-off move" in announcing the devaluation has been dismissed by the market, which is bracing itself for as much as a 10 per cent slide in the redback's value before year-end.
For some time, it has been clear that the world's No. 2 economy is in worse shape than Beijing was letting on. There is a pile-up of unsold homes in Chinese cities. Several key indicators are down. Other tell-tale signs abound, including capital flight, as people seek safer havens for their money. The central bank had been using up considerable amounts of its vast foreign exchange reserves to shore up the currency, to a point that it had become untenable. Based on all these, there was little reason for the yuan to have run up so much against the US dollar in the past year, causing a misalignment between the market's view of the currency's actual value and its official price.
Now, by weakening its money, Beijing has made its exports more competitive. More importantly, by making imports dearer, it has, in effect, exported the deflation it has been enduring at home. This signals the nervousness Beijing feels about the slowdown in its economy with its likely knock-on effects on social stability. One might ask if the global role it aspires to is taking a back seat now to protect its own interests first. Notably, during the 2008 global financial crisis and the Asian economic flu of 1997-98, China had refrained from competitive devaluation.
There is a sobering lesson here for much of Asia, which has looked to the Chinese engine to power economies. A US$10 trillion (S$14 trillion) economy expanding at 7 per cent adds US$700 billion of output to the world, providing attractive pickings for exporters from Brisbane to Bangkok, not to speak of Berlin. The double-digit pace of expansion of old is unlikely to ever return. The gravy had to run out at some point, and it has. In time, the mainland's growth cycle will resume but it stands against economic history to assume that a maturing economy will have the same legs of old.
Against this backdrop, South-east Asian nations would be well-advised to diversify their export base, acquire and sustain comparative advantage in different areas, speed up their economic integration, and draw more strength from each other. They also should widen their trading horizons by, for example, striking out in South Asia and Africa.