The Impact of Chinese Economic Slowdown on Global Forex Markets

The Impact of Chinese Economic Slowdown on Global Forex Markets

Reading time: 5 minutes

As the top manufacturing country (accounting for more than 30% of global manufacturing output) and the second largest economy worldwide according to GDP (Gross Domestic Product), China’s role in the global economy is extensive. However, the country continues to face economic headwinds, with the Chinese government attempting to reignite its economy through fiscal stimulus.

Needless to say, a Chinese economic downturn can significantly influence the global economy and financial markets. 

China’s Economy: Fundamental Challenges Now and Ahead

Between 2000 and 2020, China represented one of the fastest growing economies worldwide, and as per GDP (data derived from the International Monetary Fund [IMF]), it averaged around 10% growth per year. Subsequent years, nevertheless, have been uninspiring; average GDP growth dropped by 50% and, according to the IMF, is projected to slow further in the years ahead (see the chart below).

Source: International Monetary Fund (IMF)

China’s current economic slump stems from various influences, including a property market in disarray (homebuyers losing confidence in an overbuilt economy), deflationary pressures, global trade tensions, cautious consumers, local government debt burden, and ageing demographics. 

Deflation concerns have primarily become ingrained at the wholesale level – most economists track PPI inflation data from China (Producer Price Index – measures the average price change domestic producers receive for their output). As you can see from the PPI chart below, producer prices have been falling since late 2022. Deteriorating producer prices can mean a contraction in economic activity, lower economic growth, and less income for producers. This is because consumers may delay purchases if they expect prices to fall in the future.

Following Donald Trump’s presidential election win on 5 November, a Republican-led Congress also undoubtedly adds to China’s economic woes, particularly as the current Chinese economy is more vulnerable compared to its state during Trump’s first term. In response to the election result, China conducted US$1.4 trillion (10 trillion yuan) of stimulus on 8 November, mainly in line with economists’ estimates. The Chinese government has also been relatively forthcoming in expressing the need for further stimulus measures next year. 

However, the size of the US incoming tariffs, timing, and China’s response remains to be seen. That said, markets are unlikely to wait long; it is expected that Trump’s administration will implement tariffs on China immediately.

Brief Introduction to China’s Currency

The country’s official currency is the Renminbi (RMB), and the currency unit is yuan (CNY – usually represented by the symbol ‘¥’). As one of the oldest and one of the top five most used currencies for global payments, it translates to the ‘People’s Money’. The terms ‘Renminbi’ and ‘yuan’ are used interchangeably. 

What is important to understand is that the Renminbi covers two markets: ‘onshore’ and ‘offshore’. 

CNY trades within mainland China – this is the onshore market that facilitates interbank transactions and is controlled/restricted by the Chinese government. 

Launched in 2010, CNH is China’s offshore currency, and its value is determined freely by market supply and demand (‘H’ refers to Hong Kong as this was the first of many countries where China lifted restrictions on RMB settlement). The primary use of this free-floating version of the Renminbi is to facilitate international transactions and investment. Businesses from abroad that trade within mainland China can receive payments in CNY. However, if they intend to use these funds outside of China, they must convert the onshore CNY into the offshore CNH.

How Does the Downturn in China Influence Foreign Exchange Markets?

A weakened Chinese economy can lead to a more volatile and uncertain global foreign exchange market (Forex). Currencies with significant exposure to China may experience increased volatility, and investors may seek safety in traditional safe-haven currencies. It's imperative to recognise that the specific impact on different currencies will depend on various factors, including the severity of the economic slowdown in China, the reaction of global investors, and the overall global economic environment.

The current economic slump in China has most visibly provoked a depreciation in the yuan versus the US dollar – the USD/CNH currency pair is up 2.5% year to date. This selloff can also influence its peers in Asia. Asian currencies may be pressured lower due to weak Chinese sentiment and softer demand for exports to China. Currencies affected include the South Korean won (KRW), the Taiwanese dollar (TWD), the Singapore dollar (SGD), and the Thai baht (THB).

Commodity currencies are also likely to be affected in countries that export commodities to China, like Australia, New Zealand, and Brazil. Reduced demand for commodities, leading to lower prices in the commodity market, can affect currency values. By way of an example, given the current economic troubles in China, the Australian dollar (AUD) and the New Zealand dollar (NZD) have lost nearly 7% and 9% year to date, respectively.

On the other hand, safe-haven currencies like the USD and Japanese Yen (JPY) could also strengthen as investors seek safety during economic uncertainty. The USD, per the US Dollar Index, is up nearly 6% year to date.