Economy

Why China's currency is strengthening and what it means for the rest of the world?

Updated : January 14, 2021 10:44 PM IST

Yuan has shot up to its strongest level in two and a half years against the US Dollar in 18 months.

This strength in currency means a brighter outlook for global growth; it promises to fire up bets on looser international financial conditions.

China's economy is the world's first economy to recover from the blows of the pandemic, and its currency has hitched a ride.

The yuan has shot up to its strongest level in two and a half years against the US dollar in 18 months. And at 6.46 CNY per dollar Monday, it looks poised to jump even more. In mid-2014, the currency was hovering pretty close to breaching 6 CNY.

This might not seem like a big deal for any other currency, but for China, which is notorious for keeping a tight leash on its currency, it is unusual.

A stronger yuan has direct implications for companies that have factories in China. It could make those goods costlier in the rest of the world; the key word being 'could'. The effect is muted so far.

Why is the yuan strengthening?

If you've read reports on China's economic recovery, it might not come off as a surprise for you. In an otherwise bleak global economy, China's stars are shining.

Despite Wuhan being the epicentre of a virus that paralyzed the world, it ended the year stronger than it started. Its factories are charging ahead in full steam, and consumers are shopping with an amazing zeal. So a recovering economy seems to have lent support to yuan.

Like a magnet to iron, investors are getting attracted to China. At a time when interest rates around the world are approaching zero, China's benchmark rates (at 3.85 percent) look lucrative. Higher returns have encouraged investors to buy yuan assets.

However, some of the yuan's strength is relative. The US dollar has been weakening as the Chinese currency is gaining. With respect to euro, the yuan has barely changed, with the euro itself gaining 9.9 percent against the USD since then. But what this means is a weakened USD might further push investors to move their money to safe-haven currencies and riskier assets — emerging markets such as China being the prime destination.

Besides, a strong currency advances the ambitions of China's conservative government. One, Beijing wants to encourage the development of the domestic economy in China. A strong currency lowers the price of imported goods and boosts spending. Two, a weakened yuan had started encouraging outward flow of assets. A stronger currency will bring them right back.

Plus, the yuan will become more popular among investors if it continues to deliver gains to Chinese asset holders. Three, politicians like to consider an advancing currency a sign of development and strength.

Some analysts have pegged a strong yuan as a great diplomatic move. They believe a rising yuan is a subtle signal to Washington now that Biden is set to take charge. It might placate Biden and soften him on trade matters. Biden has already said he will review the tariffs Trump put in place. So China is hoping to get rid of some of the punitive tariffs.

So a rising yuan might come as a piece of good news for Washington which is perpetually worried about its weakness. (By keeping its currency weak in the past, China ensured its products were the cheapest in the world. Also, a weak yuan meant Chinese consumers would find American products costlier.) But unusually, Beijing is just as happy.

So what does this odd arrangement that makes both rival economic powers happy mean for the rest of the world?

Impact on rest of the world

The strength in currency means a brighter outlook for global growth; it promises to fire up bets on looser international financial conditions.

Hong Kong is one market which will be acutely impacted by Yuan's appreciation. When the currency registered growth early in January last year, Hong Kong markets gained as much as 11 percent — a level it was trading before political protests.

In the neighboring continent, a strengthening yuan is potentially good news. European markets can cope with a weaker Chinese currency, but they usually benefit from its periods of strength, more so luxury goods manufacturers. Since yuan began rising, MSCI Europe Apparel and Luxury Goods Index gained as much as 3 percent.

China consumes about 7 percent of German exports, so if the buying power of the Asian nation increases, Europe's biggest economy stands to gain.

Finally, China is also the largest consumer of copper and gold, so a stronger yuan would make both the commodities cheaper for local consumption — thereby impacting their European counterparts positively.

Why China's currency is strengthening and what it means for the rest of the world?

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