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China creating big trouble for emerging markets

Today it was announced by China that it has shifted its fix against the dollar resulting in a 1.9% devaluation of the renminbi.

The question for investors now is whether this is just another relatively innocuous chapter in a long, well known story or something concerning, which requires an asset allocation response.

On one hand, you could easily take the view that many countries around the world have played, and are still playing, the devaluation game and this is no different to what we have seen before.

Weakening a currency through monetary policy is a simple and effective economic tool based around the fact that it makes products and services for export cheaper on a relative basis, and therefore more competitive.

The Chinese government’s latest pull on this particular lever might not be repeated any time soon, and if not, it is conceivable that there will be no serious issues for investors.

One potentially worrying way to explain China’s move however, is to view it as a sign of increasing desperation.

As has been well documented recently, China has seen a sharp slowdown in the rapid double digit economic growth it enjoyed for a sustained period.

This decision could be seen as a sign of panic among the leadership, and an indication that as some believe, China’s economy is doing worse than the publicly declared numbers would suggest.

The timing would lend itself to this view. Many market watchers and economists felt that China would not want to rock the boat with such a big monetary move ahead of a decision on the renminbi’s inclusion in the International Monetary Fund’s special drawing rights category, a step towards being considered a global reserve currency.

“The change should help with China’s goal of making the renminbi a global currency, but was poorly handled, said a skeptical Bhaskar Laxminarayan, CIO of Pictet Wealth Management Asia. “Further gradual renminbi depreciation is now likely, and other regional currencies now face downwards pressure. There will be little benefit for China’s economic growth.”

Part of the Bonhill Group.