China devalues the yuan, raising fears of currency depreciation in EA

East African economies are caught up in a global currency war that could see the local units weaken in the face of cautious devaluation of the Chinese yuan and a US interest rate hike that could come as early as next month.

Currencies of other emerging markets have depreciated against the US dollar following the yuan devaluation a fortnight ago continuing the defensive currency wars that started with the devaluation of the Swiss franc earlier in the year.

At the heart of the currency wars are moves by major economic powers to increase their share of international trade by selling more, a goal made easier when the local currency is weaker.

A weak currency makes exports cheaper while discouraging imports from other countries. Higher interest rates that help attract foreign capital inflows are also an element of protective wars.

A fortnight ago, China devalued its currency by 4.17 per cent. Previously, the Chinese government had tried reducing interest rates, injecting liquidity into the market and reducing bank reserve requirements, all as stimulus measures.

READ: China’s devaluation of yuan to hurt import-reliant emerging markets

China People’s Bank chief economist Ma Jun however said that his country’s devaluation was in no way part of the currency wars.

“The Chinese government has absolutely no intention to participate in currency wars. We will only intervene on the Yuan under exceptional circumstances to counteract excessive volatility of the currency,” Mr Jun told Reuters, to deflate counter-devaluations from the US and EU.

The International Monetary Fund has welcomed China’s move to make the yuan subject to a free floating exchange rate, a condition the Fund has set for accepting the yuan as part of its Special Drawing Rights basket of reserve currencies.

A decision on this is expected later this and if positive, it would make the yuan a global reserve currency, stealing into some of the dollar’s clout.

READ: Africa to benefit from China’s push for yuan as global reserve currency

But the devaluation is causing a ripple effect in emerging markets and commodity based currencies as fears of similar defensive moves that could rope in frontier markets like Kenya loom large. Brazil has already devalued the real and seen a notable boost in its exports.

Kevin Tuitoek, a research analysts at Genghis Capital, said that currency interventions are increasingly seen as attractive by many developed countries options for enhancing growth rates.

As China registered declining growth rates, followed by the market route that has wiped off large investments from the stockmarket, the Chinese government proceeded to devalue its currency, which came as a surprise.

“This had a knock on effect on an array of Asian trading partners, with multiple currencies taking a plunge. The effect of the devaluation made Chinese goods more competitive, while the US dollar strengthened and American products became more expensive,” Mr Tuitoek said.

Most economists say that the US market is relatively well insulated from the contagion brought about by the devaluation. However, most also argue that the European Union faces a different set of complexities as it is in the process of carrying out its own quantitative easing (QE), which has had the effect of weakening the euro and enhancing exports.

In January, Yi Xianrong, a researcher with the Institute of Financial Research at the Chinese Academy of Social Sciences, said that the QE programme by the EU altered the yuan-euro dynamics, effectively depreciating the value of the yuan.

Francis Otieno, an economics lecturer at Kenyatta University, said that the global currency war leaves the emerging markets exposed, especially now that they are dealing with the problem of already weakened currencies.

“We are seeing the emerging markets adversely affected by the currency wars affecting currencies and various asset classes globally,” Mr Otieno said.

Already, within the Asian market, currencies such as the Singapore dollar, Malaysian ringgit and the South Korean dollar are facing downward pressures post the devaluation of the yuan.

Within East Africa, the knock -on effects will lead to enhanced current account deficit pressures.

Within the sub-Saharan African market, Angola, Nigeria and Zambia are the only countries that have resorted to devaluations this year.

The US Fed rate hike that is expected within the next few weeks has sent jitters throughout emerging markets.

US asset classes will be viewed as more attractive when the Fed rate hike comes into place.

Mr Tuitoek said that unlike the QE programme that came as a shock, the rate hike has been largely anticipated as the Fed has indicated that it will maintain caution when adjusting the rate upwards, thereby limiting the overall effect of the hike.

Also, in anticipation for the hike, most emerging markets have pre-empted the rate hike through monetary policy interventions that has seen their own rate hikes coming to the fore. In the East African space this has seen Kenya, Uganda and Tanzania each raise their rates to mitigate against severe currency volatility.

“We understand that a rate hike by the Fed will have some pressure on the already repressed currencies, but there shall be some reprieve that the rate hike may be tempered in a more subtle manner than anticipated,” Mr Tuitoek said.

Daniel Kuyoh, an analyst at Kingdom Securities, said that most African currencies have been on a losing streak because of the expected US rate hikes in September, the devaluation of the yuan brings in another dilemma for the region and sub- Saharan African markets and currencies.

“Now that China has broken the peace with its shock devaluation, most investors are adopting a wait-and-see attitude on other economies that will join the fray. The pressure this will cause will most certainly see other devaluations from not only China but also emerging markets and developed economies,” Mr Kuyoh said.

Within the sub-Saharan African market, Angola, Nigeria and Zambia are the only countries that have resorted to devaluations this year.