How is China’s Bad News Affecting Emerging Market Currencies

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How is China’s Bad News Affecting Emerging Market Currencies?

By Lex Yaranu | Monday, August 24th, 2020

These are not the best of times for emerging markets, but could turn out to be the sweetest period of the year for binary options traders. It looks like China’s woes are taking more of a toll than most people thought, and most of that till is being taken by emerging markets.

Yesterday, the news emanated from Kazakhstan that the central bank in that tiny nation had decided to allow its currency to float after spending so much in unsustainable attempts at pegging their currency, the Tenge.

After unsuccessful attempts at a controlled depreciation 24 hours earlier, the Kazakh Central Bank decided to allow its currency to float fully as China’s economic news took its toll, forcing the Tenge to plunge by 22% on Thursday August 20, 2020.

The Tenge is not the only emerging market currency that has been hit this week. The Vietnam Dong was also devalued while the Turkish Lira and South African Rand suffered hefty losses for the week. To underscore the significance of the losses suffered by the Rand, the ZAR has not hit the 13.0000 mark against the US Dollar since December 2001.

The origin of these currency shocks was the decision of the People’s Bank of China to devalue the Yuan for three straight days in a desperate attempt to cheapen Chinese exports and kept the Chinese economy on track to meet the 7% GDP target set by the central government earlier in the year. With cheaper exports, China which has historically competed with its Asian neighbors for a share of regional and global markets in certain industries like the textile markets, gained an advantage which countries like Vietnam, Malaysia, South Korea and Kazakhstan have been unable to match. Furthermore, the weakness of the Russian Rouble as a result of crippling Western sanctions has mean that exporting goods priced in costlier currencies against a market with a much cheaper currency has proven untenable.

Several emerging market currencies are already under severe pressure from collapsing oil prices: Saudi Arabia’s Riyal, the Nigerian Naira, Malaysian Ringgit, Egyptian Pound and the Ghanaian Cedi are under heavy pressure.

Similarly, copper producing countries such as Zambia and Australia which export most of their copper ore to China are facing severe pressure as the Chinese economy shows signs of not being able to meet the 7% GDP target.

These scenarios have all created a very interesting picture in the currency and commodity assets for binary options traders. It is left for traders to study the fundamentals and use technical entries to ensure the best possible plays that will end in profit.



The level of U.S. tariffs on Chinese products and the number of goods they cover are constantly changing as the trade dispute between the world’s two largest economies escalate. To help investors evaluate the possible macroeconomic impact from the trade war, we put together a back-of-the-envelope economic analysis (Figure 1). Like any similar approach, it contains many simplifying assumptions and will not fully capture the complex reality of the dispute’s economic impact, but it will provide a framework for evaluating the effects on inflation, corporate profits, Federal revenues and Chinese GDP. As is the case with monetary and fiscal policies and currency movements etc., there are many second and third order possibilities to consider.

Let’s break down the assumptions into their four categories:

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U.S. Inflation

Import tariffs are essentially a sales tax and raise costs for consumers. The question is by how much? The simplest assumption is that consumers will bear 100% of the cost of the increased tariffs. For example, if the U.S. has a $20 trillion GDP and the government imposes a 10% tariff on $200 billion worth of imported goods, then U.S. consumers would see the average price level rise by 0.1% (10% X $200 billion / $20 trillion).

The good news for consumers is that this calculation ignores the notion that some of the impact on consumer prices will likely be absorbed in the form of lower corporate profits – both in the United States and China. Additionally, the trade war negatively impacts China’s renminbi (RMB) and through it many emerging market currencies (Figure 2).

Weaker emerging market currencies translate to lower import costs for U.S. consumers, offsetting a portion of the tariff impact. As such, we assume that roughly half of the consumer impact from higher tariffs will be absorbed elsewhere.

Corporate profits

If 100% of the impact of the trade dispute came out of corporate profits, a 10% tariff on $200 billion worth of goods would lower U.S. corporate profits by the equivalent of 0.05% of GDP. Since corporate after-tax profits are around 9% of GDP, that would mean that corporate profits would fall by around 0.5% or 0.6%. If the tariff goes to 25%, then U.S. corporate profits could fall by 1.25-1.5%, if the impacts of the trade dispute were fully absorbed by lower profit margins. However, some of the costs are likely to be passed along to consumers.

Moreover, some of the negative impact of the trade war will also be buffered by Chinese enterprises, which may offset some of the tariff impact by lowering their own profits margins. Finally, if the value of the Chinese currency falls (and it already has) and drags other currencies lower, this could also hurt U.S. corporate profits. As such, we estimate that about half of the cost of the tariffs will in one way or another be borne by U.S. corporations by way of lower profit margins.

Compared to the size of corporate profits, the tariff impact is relatively modest, which may explain why U.S. equities aren’t too troubled by it. It may also explain why the tech heavy NASDAQ and the small cap Russell 2000 have outperformed the multinationals-dominated Dow Jones Industrials Average and the S&P 500®. Many of the big U.S. tech firms that dominate the NASDAQ 100 (Google, Amazon, etc.) have limited access to Chinese markets and are relatively unaffected by China’s retaliatory measures. Likewise, many U.S. small caps focus on the domestic market and their supply lines are not likely to be negatively impacted like those of the bigger firms that dominate the Dow and S&P.

Federal revenues

Trade disputes aren’t all bad news. Following the tax cuts and spending increases, the Federal deficit ballooned from 2.2% of GDP in 2020 to over 4% this year and could hit 5.0-6.0% in 2020. Tariffs are a tax and imposing tariffs raises revenue for the Federal government.

Some of the revenue raised directly from tariffs could be offset, however, by lower tax collections from corporate taxes to the extent that the trade dispute lowers corporate profits. Also, if the trade war slows job creation or wage growth, it could lower personal income and payroll tax collections. By our estimate, a 10% tax on $200 billion worth of Chinese goods will bring in about 0.1% of GDP worth of tax revenue. A 25% tax will bring in around 0.2%. These revenues will reduce the Federal budget deficit very slightly, but they won’t be nearly enough to halt the rapid growth in Federal deficits.

China GDP

Valued at current exchange rates, China has a $12 trillion economy. A 10% U.S. tariff on $200 billion worth of Chinese goods will probably erase about 0.1-0.2% from GDP. A 25% tariff could widen that to 0.3-0.4% of GDP, all else being equal. The good news for China is that all else isn’t equal. China can counter some of the negative impact by allowing its currency to fall and the RMB is already down by about 9% since mid-April. Moreover, China has other tools at its disposal, including monetary and fiscal stimulus. A tax cut will go into effect in September and the People’s Bank of China (PBoC) has already reduced its reserve requirement ratio twice in the past four months. As such, some of the negative GDP impact can be partially offset, at least in the short run.

“All else equal,” doesn’t necessarily work out in China’s favor, however. China has high debt levels and slower growth could make it more difficult to deleverage its economy. Moreover, high levels of leverage could foster a negative spiral where slower growth leads to business failures and defaults which, in turn, lead to even slower growth and more failures and defaults. The Chinese government and the PBoC have the ammunition to prevent such a spiral from occurring in the short term, but by easing fiscal and monetary policy they risk increasing public and private sector debt. As such, if the trade war chickens don’t come home to roost now, they might later and in greater numbers.

Other limitations

Our set of back-of-the-envelope calculations also does not account for China’s response to the U.S. tariffs. Any retaliatory measures will likely boost consumer prices in China, lower profit margins and GDP growth on both sides of the Pacific and raise a small amount of revenue for the Chinese government, whose public debt is growing. Once again, our back-of-the-envelope model is not intended to make a precise economic forecast. We also don’t consider the possible impact on U.S. monetary policy, which could become either tighter or looser in response to the trade dispute than it might otherwise be. Rather, it is our hope that the calculations below will provide a useful framework for considering possible economic implications of the trade dispute on the U.S. and Chinese economies, both of which are extremely complex.

One last point: we also calculate the impact of applying tariffs on all Chinese goods coming into the U.S. which total about $500 billion – so $300 billion in addition to the $200 billion already likely subject to tariffs.

Figure 1: Possible Economic Impact Under Three Scenarios (Tariffs on $34B, $200B & $500B of Goods)

Under a worst-case scenario that a 25% tariff is applied to all Chinese goods, one could see a 0.3% rise in U.S. CPI, a similar fall in corporate profits as a percentage of GDP (so about a 3.3% drop in overall corporate profits) and a 0.8% hit to Chinese GDP. On the other hand, if one sticks to the Administration’s original proposal of 10% tariffs on $34 billion of goods, then the impact of the trade dispute is negligible.

Figure 2: Both the Renminbi and Other Emerging Currencies are Falling

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

Erik Norland is a Senior Economist at CME Group

Look: The moment the rand, and 5 other emerging-market currencies, followed the Turkish lira into meltdown

The South African rand weakened by more than 10% against the US Dollar in the early hours of Monday morning as concerns over Turkey’s diplomatic spat with the US, and capital flight risk, sparked turmoil in markets.

See also: ‘Clear risks of contagion’: European markets drop as Turkey’s lira crisis spreads around the world

As Asian foreign currency markets opened on Monday, the Turkish lira continued to plunge to all-time lows, negatively affecting the rand, which followed suit and fell to a low of R15.70 from opening at R14.06 — making it the deepest rand plunge against the dollar in two years.

Have a look at this move just now in the South African Rand. USD-ZAR just popped 10% . granted of course there’s very thin liquidity in this during Asia

Similar meltdowns were recorded in other emerging markets.

Here are five other emerging market currencies also affected by the on-going Turkish Lira meltdown:

1. Mexico’s Peso

Traders backed away from the Mexican Peso as fears mount over emerging markets. The Mexican Peso weakened to a low of Mex$19.32, or about R14.44, to the US dollar.

2. Russia’s Ruble

The Russians were not spared from the sell-off in emerging market assets. The ruble slumped to a near two-and-a-half year low, also as a result of last week’s surprise sanctions by the US.

3. Brazil’s Real

Although the Brazilian markets are yet to open, massive sell-offs in the currency have been taking place prior to the start of trade in South America.

4. India’s Rupee

Although Asian countries do not have a meaningful exposure to the Turkish lira collapse, the Indian rupee also took a knock that saw it hitting an all-time low of 69.92 (about R14.49) against the dollar.

5. China’s Yuan

The mighty Yuan also fell against the US dollar. The Chinese currency slumped 51 basis points to ¥6.87 to the dollar (about R14.48).

It is premature to say just how long and how much the lira crisis will impact markets, Kim Doo-un, a Seoul-based economist at KB Securities told Reuters – especially markets with a thorny relationship with the Trump administration.

But volatility for the rest of the week is a pretty sure bet.

More on the Turkish meltdown and its impact:

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Also from Business Insider South Africa:

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