China devalues its currency – is this good for Australia?

Report

Expect the unexpected


The past quarter has not been for the faint-hearted investor, with global markets subject to the Greek bailout crisis and fears of the Chinese economy slowing.

The outcome for Greece was binary. Either they agreed to tough terms from its lenders or it defaulted and suffered the prospect of terrible social and financial consequences. Sense prevailed.

Meanwhile, there has been much conjecture on the growth outlook for the world's second largest economy, China. To put this into perspective, the value of China's economy has grown from  $US1.6 trillion in 2000 to $US10.7 trillion over the past 14 years, driven by a massive program of urbanisation – improving the living standards of the growing population with needs for housing, transport, communication and jobs.

No wonder there was a commodities boom, which Australia benefited from and will continue to do so as China's plans to urbanise are ongoing.

Prior to the global financial crisis (GFC), China was growing at about 12% but during the worst of the GFC the lowest growth recorded was 6%. At the time, all governments and central banks around the world kick-started their economies by stimulating infrastructure spending and making significant reductions to interest rates.

China reacted to that demand and its growth recovered to 10%. These big swings in activity are not helpful for an economy of China's size when it is re-structuring to accommodate increasing numbers of consumers with higher disposable income while also liberalising economic reforms. Stable growth would make this much easier.

As China's exports grew so did the value of its currency. But now, with slowing global demand for its exports, China has decided to re-balance by devaluing the currency by 3%. This is a sensible move to make their exports cheaper. To put this into perspective, the Euro has devalued by 16% over the past year and the Australian dollar has devalued against the US dollar by 20%.

So why the adverse reaction to China's currency move by global markets?

The Chinese economy has slowed but not to the extent global markets had forecast. In fact, Macquarie's economists are of the view that the significant stimulatory measures China has made , such as investment in infrastructure and five interest rate cuts over the past year for example, will gain some traction and that we are seeing the bottom of the cycle now.

China's devaluation of its currency is in part to assist exports. But it is also one of a number of 'baby steps' to continue to liberalise the Chinese economy towards more market orientated economic settings.

So how does this affect Australia? It will make Chinese goods slightly cheaper for Australia's consumers and businesses, which is a good thing. By keeping imported prices down, inflation is likely to remain low.

Low inflation gives the Reserve Bank room to cut rates again. Macquarie forecasts this will happen in November, predicting a 0.25% decrease to 1.75% as business investment is needed to substitute the growth that the mining investment boom was providing.

The global reaction has also seen the Australian dollar fall from US74 cents to US71 cents over the past few weeks, aiding the rebalancing of our economy in a further boost for Australian exports.

So we should expect China's growth to stabilise, but that's not a cause for major concern. One thing is for sure – it's time to expect the unexpected, as nothing is certain in today's global economy.

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