The shipping industry should not read too much into a negative knee-jerk reaction from commodity markets to China’s currency devaluation
China’s decision to devalue its currency for two days in a row last week put commodities prices in a tailspin and sent jitters through the financial and economic communities. But is it really such a harbinger of further doom for shipping?
‘Commodities crumble on China devaluation’, ‘China digs a hole for commodities’, ‘Shock China devaluation unhinges commodities’ read some of the sensational headlines. The move from the Chinese authorities pushed the yuan to its lowest level in four years and fanned fears that its economy is in worse shape than previously thought. There were immediate losses on stock exchanges around the world: on Wednesday, London’s FTSE 100 fell nearly 1.4% on the back of the news.
But Chinese imports of commodities were falling long before the currency depreciation and the stock market slump. So were the real estate and construction sectors, coal production, power production, steelmaking and other key indicators of the Chinese economy. Chinese exports were down by more than 8% in July, proof of weaknesses before the currency devaluation. Shipping companies were dealing with sluggish China demand long before this week’s currency moves.
“The devaluation of the yuan is unlikely to affect demand for seaborne iron ore in China as most high-cost domestic mines are already shut”
Pros and cons
In fact, the devaluation is not necessarily a bad thing for shipping, depending on which side the coin lands. A cheaper yuan should boost Chinese exports by making them less expensive on overseas markets. More money in on exports could give the Chinese a reason to bolster imports or, less positively for shipping, it could encourage investment in increased domestic production to the detriment of global imports. Add to the mix that a rise in export sales could lead to increased imports of raw commodities such as crude, iron ore and bauxite. However, much depends on whether the US and other Asian nations follow suit with devaluations of their own currencies to remain competitive.
Analyst Macquarie stated in a report that the devaluation of the yuan is unlikely to affect demand for seaborne iron ore in China as most high-cost domestic mines are already shut. While the move may prompt some higher-cost mines to produce for longer, the industry has already largely consolidated, the analyst said.
“A large proportion of China’s high cost mines have already been shut and hence China’s production share is small and the cost curve is not nearly as efficient as it used to be,” the report said. However, it added that the coal market could see more of an impact: “We would highlight coal (thermal coal in particular) as the most likely to be affected, given China’s large production share and high cost structure.
“But Chinese protectionism of the domestic coal sector, characterised by high-cost state-owned enterprises, means that the seaborne and China domestic coal markets are gradually decoupling.”
Macquarie added that there is a debate to be had about “whether China is really the price-setter”.
While the shipping markets wait to see which way the cookie will crumble, the commodity markets did not take the news well. On Tuesday – the day of the first devaluation – copper fell 4% to a six-year low of $5,114 a tonne and Brent fell by nearly 3% to settle below $50 a barrel. However, to put this in perspective, iron ore prices have already dropped over 40% over the past year, while oil has slumped 55%.
Brazil stands to lose the most from China’s decision to devalue its currency. It sends half of its commodity exports to China and a weaker yuan threatens to lower prices which are already under pressure.
The reasoning behind the devaluation remains unclear, but three interpretations have been offered up by investors. First, China has moved to unwind some of the large surge in the yuan’s value over the past year or so. Second, sluggish growth momentum has prompted the adjustment as a partial correction for that. Third, China is taking steps to move towards a more market-based exchange rate.
This latter point carries some weight as the Chinese government is extremely keen for the International Monetary Fund to include the yuan in the basket of currencies that comprise the IMF’s reserve assets that are known as special drawing rights (SDR). The yuan would sit alongside the US dollar, the euro, the Japanese yen, and the British pound in the SDR and its inclusion would be an acknowledgment that the yuan has become an international currency. The IMF requires that reserve currencies must be freely usable and the fund has said in recent months that the yuan needs to be more flexible.
Indeed, the IMF welcomed the devaluation moves. In a statement, the IMF said: “The new mechanism for determining the central parity of the Renminbi announced by the PBC appears as a welcome step as it should allow market forces to have a greater role in determining the exchange rate.”
In fact, all three interpretations likely have some element of truth to them, but regardless of the intention the devaluation just goes to confirm concerns that China is locked in a slower growth path with no easy way to turn its fortunes around.