China's devalued yuan bad news for Canadian resources

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Economists say China's surprise devaluation of its currency is the latest sign that the country's massive economy is slipping more than its government wants to let on – which is bad news for Canada's beleaguered resource-producing industries and regions.

China's central bank lowered its peg on the yuan by nearly 2 per cent Tuesday, a move that appeared to be at least in part tied to efforts to further liberalize trading in the historically highly state-managed currency. But most observers saw the timing of the devaluation as the latest in a series of escalating steps by the Chinese government to light a fire under the country's economy, which continues to show signs of cooling. News of the devaluation triggered selling in commodities and commodity-sensitive currencies, such as the Canadian dollar, amid concerns that China's notoriously huge appetite for natural resources may be waning more than expected.

According to China's official figures, its gross domestic product grew at an annual rate of 7 per cent in the first half of the year – booming by Western standards and in line with the Chinese government's 2015 growth target, yet on pace for the slowest year for the rapidly expanding economy since 1990. But, based on Chinese officials' escalating efforts to stimulate the economy, including central bank rate cuts, market interventions and now a devaluation, there are rising concerns that China's growth is even slower than the government's official GDP data let on.

"They're behaving nothing like a government that's on target," said Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce.

Economists said that, while China's internal calculation of GDP is a notorious statistical black box, more independently verifiable economic data suggest the economy isn't growing nearly as strongly as 7 per cent this year. Indicators of China's manufacturing activity are at three-year lows, and indicate that the country's vital manufacturing sector has been in contraction for the past five months. Last week, Chinese exports for July came in at 8.3 per cent below year-earlier levels.

"The Chinese economy is in very bad shape. They're lying about their GDP data, obviously," said Sherry Cooper, chief economist at Dominion Lending Centres.

And that's bad news for a major commodity exporter such as Canada – despite the fact that China is still only a relatively small market for Canadian exporters.

Although Canadian trade with China has grown dramatically over the past decade, China still accounts for only about 4 per cent of Canada's exports. While that makes China the No. 2 market for Canadian exports, it's a drop in the bucket compared with the 75 per cent that go to Canada's biggest trading partner, the United States.

But China's more important role in Canada's economic fortunes is its strong influence on prices in Canada's critical natural resource sectors, which make up roughly half of Canada's exports and more than 10 per cent of GDP. As the world's biggest consumer of commodities, as well as the key source for growth in world commodity demand in recent years, China's pace of economic growth is a key factor in setting global commodity price trends. Those standards dictate the prices Canadian commodity producers receive, regardless of the destination of their products.

"That has far wider implications for the Canadian economy, beyond the exports there," said economist Jayson Myers, CEO of Canadian Manufacturers & Exporters, a leading industry group. He said the continuing China-driven decline in commodity prices not only hurts the value of Canadian resource output, it discourages investment and lowers Canadian asset values.

"It's certainly not good for the parts of Canada that are already suffering from that," said Ms. Cooper, suggesting that struggling Alberta could see further rounds of job cuts.

One possible silver lining of China's devaluation, and the spillover to commodity currencies, is that another downward leg in the Canadian dollar could make Canadian exports more attractive to foreign buyers. But economists said that, with other currencies also losing ground against the U.S. dollar, and with other export-oriented countries – including China – happy to adopt policies that are driving down their currencies in order to stimulate exports, this latest fall in the loonie may not do much to lift Canada's prospects against its global competition.

On the other hand, CIBC's Mr. Shenfeld argued, the Chinese government's multipronged efforts to stimulate the country's economy should pay dividends in terms of restoring growth – which should eventually fuel a recovery in commodity demand and prices, to Canada's benefit.

"The upside is that China isn't just sitting there content to watch its economy decelerate. It's doing something," he said. "This is one step out of many that could lead to better growth in 2016."