Sluggish economic growth has plagued Asian economies for the past two years. The combined effects of falling commodity prices, weak global demand for exports and soft internal demand have led to year-over-year (YOY) declines in the gross domestic products (GDPs) of the largest Asian economies. Chinese GDP growth fell from 6.8% in March 2015 to 6.7% in 2015. Meanwhile, GDP growth in Japan plummeted from 0.7 to 0.1% in March 2016, while in South Korea, growth dipped from 3.1% to 2.8%.
The declines in growth have led policymakers in the region to pursue aggressive measures to weaken their currencies. A weak local currency makes a country's goods less expensive for foreign buyers. While consumption remains anemic, a weak currency provides a way to prop up growth with exports.
Japan's Response to Economic Doldrums
Japan, which is the world's third-largest economy, has experienced uneven growth for many years. Prime Minister Shinzo Abe has advocated increases in government spending and temporary tax cuts to boost growth. However, the country has dipped in and out of recession during Abe's administration, and many economists called for a stronger policy response. In January 2016, the Bank of Japan (BoJ) voted to cut interest rates below 0%, citing lower oil prices and volatility in financial markets for its move.
The BoJ wants to bolster business confidence in Japan and encourage companies to borrow and invest. The move led to increases in Japanese share prices and to a weakening of the Japanese yen. The yen traded lower by 1.76% versus the dollar by the end of the day of the announcement.
Chinese Devaluation of the Yuan
China also sees a weaker currency as a solution to its economic malaise. In August 2015, the country devalued the yuan by 2% against the dollar twice within a two-day period. The nation's 8.3% drop in exports in July 2015 and a series of weak output numbers beginning in 2014 spurred the action by the People's Bank of China (PBOC). The Chinese yuan generally tracks the U.S. dollar; strength in the U.S. dollar in 2015 may have forced the PBOC to act quickly to weaken its currency.
The weaker yuan makes China's commodities and finished goods more competitive to foreign buyers. With weak demand from Chinese consumers, the country may need strong exports to lift its growth. A weak yuan may also help the Chinese economy by boosting employment. Export-driven companies may find the need to hire workers to produce and ship products. However, the devaluation of the yuan also reduces the purchasing power of Chinese consumers.
How Will South Korea Respond?
The actions by China and Japan to weaken their currencies may create anxiety among officials in South Korea. South Korea, which is Asia's fourth-largest economy, may see the weakening of the yen and the yuan as a threat to its burgeoning economy. In response to the yuan devaluation, South Korean markets experienced capital outflows. The Korean won lost 2% of its value on the day of the move, and equity markets also traded lower. Whether or not Korean officials wanted a lower won, the markets made the decision for them.
The lower Korean won may reflect market anxiety about the South Korean economy. China's move to devalue the yuan may cause a currency war in which other countries devalue their currencies to prop up export markets. The South Korean economy relies heavily on exports and may face competitive strains in such an event. Morgan Stanley (NYSE: MS) echoed this belief in an Aug. 17, 2015 report to investors. The investment bank placed the country on its "troubled 10" list and argued that it may face economic fallout from the Chinese move to devalue the yuan.
On the other hand, some South Korean officials remain optimistic about the yuan devaluation. Finance Minister Choi Kyung-hwan said he sees both advantages and disadvantages to China's move. He argued that China's move may help South Korea, since the latter sells many intermediate products to China. Strength in China's exports may bolster the sales of these intermediate goods. Rather than weaken the won further to compete, South Korea may benefit from China's devaluation.
