Ukraine at the epicenter of the global currency war

Author : Oleg Ustenko

Source : 112 Ukraine

A new currency war has started, and it promises to be very fierce
10:40, 27 February 2017

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A little over a month since the 45th US president took oath of loyalty to the people.

And the fears of rise of pragmatism of the new administration began more than true. This applies to all areas, including such sensitive as international finance. In recent years, the debates of 2010-2012 about currency wars have almost disappeared. It seemed that the world deals with quite different problems. It seems that even not everything is hopeless and the world does not fly into the abyss.

Now everything has changed. This was very clearly demonstrated by recent conversation between US Treasury Minister and Director the International Monetary Fund (IMF), the news about this immediately appeared on the website of the Ministry.

It was clearly stated: the US hopes that the IMF to ensure fair and deep analysis of exchange rate policy among the member countries of the Fund.

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What does it mean? A new currency war has started. And it promises to be very fierce.

While this event might seem to be quite unimportant, it has some deeper meaning that could change the existing approaches to sovereign rate policy, conducted by central banks around the world. Suddenly it became clear that these central banks could be influenced quite strongly, and even outside.

This is why many countries have nervous thinking about how to fit into a new (more pragmatic compared to previous times) realities. Of course, if these "others" would get some benefit from such a perspective. I hope that Ukraine considers oneself to the group "wanting to get some benefits."

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I would interpreted this to a telephone conversation this way. Expectations of the US Treasury is primarily that there would be serious pressure on those countries where the local currency is "undervalued."

The logic is clear and understandable. Countries in the case of trade with the United States, have significant competitive advantages. Primarily, it is about China.

The issue of undervaluing yuan in the US has been topical for a long time. And given that the United States is a key consumer of its exports to the Middle Kingdom, in the event of such an "honest" pressure and analysis China would feel much worse.

US are worried that the imports from China in 2016 exceeded to $ 500 billion (this figure is six time more than Ukraine's GDP) and its growth still continues. Only in January 2017 this figure increased by almost 10%.

There are lots of parties that do not accept China's economic expansion in the US. This was carefully voiced before. And now it is said publicly.

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Let us be sure, the Chinese did not only hear the message - by and large, it was not a surprise for them. Yes, it will make them nervous, but Beijing has the plan B. This is not just because they are always closely monitoring global processes, but because they used to work for a perspective.

In the short term, consequences for China might be the most unfavorable. Exports is not the main driver of economic growth. Gone are the days when more than 30% of China's GDP were dependent on exports.

And would never repeat, when it reached a peak share of exports, reaching almost to the level of 35%. Now it stands at about 20%. The remaining growth provides completely different factors, especially investment and domestic consumption.

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But just imagine what even 1% reduction means in numbers for Chinese exports? This is a huge figure of $ 25 billion (more than the GDP of Ukraine by separate quarter).

Why is it important to remember that we are working with big numbers that characterize the economy of a great country? Because even small changes can affect small players with extraordinary force.

Now imagine what a huge wave could form if China's exports decreases by 10%. And how will this affect small economy.

After this "diplomatic" phone conversation, geoeconomic degree of uncertainty has increased significantly. Absolutely real became the need of adjusting forecasts for growth in China.

And it is highly undesirable for Chinese authorities. Reduced exports (ceteris paribus) will immediately lead to a slowdown of economic growth.

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They would still try to sell their products. Question - where? Who will compensate possible reduction in China's foreign exchange earnings from the US?

One of the actively considered variants is Europe. But this is not that simple. If the yuan strengthen, "under the rod of the IMF" and "promotion" of the US, it will be strengthened not only against the dollar but also against the euro.

There is one possibility for China to compensate for the loss is to make its exports cheaper in the EU. But how?

A possible option is not to pay import duties. It is possible in case of a free trade zone with the EU. But in practice, in the near future it is unrealistic.

Another potential option is to open their production in the EU. However, this idea cannot be implemented in practice due to a sharp increase in costs.

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It could also try come from the side. And the Chinese authorities have already begun to test this "side entrance". Last year's statement of the Chinese Ambassador in Ukraine concerning negotiations on a joint FTA with Ukraine – was the first step.

Meanwhile, we will see a sharp increase of Chinese investors in Ukraine. Their logic is quite clear.

Why should they pay import duties when crossing the customs border of the EU (about 10% on average), if they can take advantage of the FTA. And Ukraine might become a partner.

FTA with Europe allows anyone (interested in the EU) to take advantage of it. Moreover, Ukraine has a number of advantages, including such "humiliating" ones as a cheap but skilled labor force. With an average salary in Chinese cities reaches $ 700, while a month salary in Ukraine is about $ 200, it can be a serious motivator.

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Chinese businessman might save 10% on import duties, and even on the low cost of labor Ukrainians. He would very actively begin to do it in the foreseeable future. Chinese investor is not even scared of the quality of business climate in the country.

In this scenario, there would be some additional and significant impetus to the economic growth of Ukraine, which is so essential for our exhausted economy. But in the long term perspective, it means that Ukraine might become a new "factory" of Europe with not very safe business climate.

From the one hand it would be beneficial to be a "factory", but the Ukrainian "political elite" might gladly roll out plans to reform Ukraine. They might just take a relax. Especially because in the future there would be an extra boost to growth that will make the life in Ukraine better, and the politicians would do nothing for this.

This question haunts me.

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