On December 15, when the Federal Reserve hiked the Fed funds rate in the United States, The People’s Bank of China set the yuan’s daily dollar “reference rate” to 6.93, its weakest level since May 2008. Since the start of 2015, the Chinese yuan (CNY) has declined 12 percent against the U.S. dollar (USD).
The decline has received wide media coverage, especially in light of President-elect Trump’s more muscular tone vis-à-vis China. Largely missed is the fact that the yuan also has declined against many of its emerging market trading partners, several of them countries where China is seeking deeper trade relationships.
To take a closer look at these dynamics, we construct a Chinese Yuan Other Important Trading Partners (OITP) Index, a trade-weighted index similar to the U.S. Federal Reserve’s Other Important Trading Partners Index1, and compare the Chinese Yuan OITP to the CNY/USD (Chart).
In early 2015, the yuan began to edge down against the dollar. The Chinese readopted an earlier policy of pegging the yuan to the dollar and held it at 6.2/USD from March until August 11, when it devalued the yuan nearly 2 percent against the dollar. On the eve of the much-anticipated U.S. Federal Reserve rate increase in December 2015, Chinese authorities announced that they would loosen the dollar peg and henceforth target a basket of currencies.
Meanwhile, the yuan strengthened against the emerging markets currencies in the OITP Index in large measure because many of those currencies suffered due to declining commodity prices and a global sell-off of emerging market assets. The yuan held these gains until early 2016, when commodity prices bottomed out and began to rebound (see Commodity Prices: A Bumpy Path Upward).
Since the beginning of 2016, the yuan has declined nearly 7 percent against the dollar, while our index of Other Important Trading Partners shows that the yuan has lost more than 12 percent against these currencies.
Until recently, the dominance of China’s export trade to the United States focused attention on the CNY/USD pair.2 However, given China’s potential vulnerability to Trump Administration trade policy and China’s One Belt, One Road economic and diplomatic initiative, Beijing has both economic and political motivations to diversify trade away from the United States and toward other emerging markets.
In the process of transforming its trade patterns and developing one of the world’s largest areas of regional cooperation, China will be motivated to manage its currency against these other important trading partners. As this transformation unfolds, it will be worthwhile to monitor how China manages the yuan vis-à-vis its other important trading partners.
1 Our Chinese Yuan Other Important Trading Partners (OITP) Index is constructed using trade-weighted averages of bilateral exchange rates. Using IMF Direction of Trade Statistics, we included economies with bilateral shares of Chinese imports or exports in excess of ½ percent in 2014 and 2015 (similar to the Federal Reserve’s Broad US Dollar Index). Currencies such as the euro that trade widely in foreign exchange markets outside their respective homes were excluded, as was the Hong Kong dollar because it is pegged to the U.S. dollar. The 19 Emerging Market economies included in our index are: Taiwan, South Korea, Vietnam, Singapore, Thailand, Malaysia, Indonesia, the Philippines, India, Pakistan, Saudi Arabia, United Arab Emirates, South Africa, Nigeria, Russia, Turkey, Brazil, Mexico and Chile. For further background on the index construction, see https://www.federalreserve.gov/pubs/bulletin/2005/winter05_index.pdf
2 According to the IMF’s Direction of Trade Statistics, China’s top export partner in 2014 and 2015 (latest available data) was the United States, followed by the European Union, Hong Kong, Japan and Korea.
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