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In this article,
we would discuss yuan’s recent devaluation and the ripples it caused world-over.
In the second week of August 2015, China devalued its currency yuan (officially called renminbi) by nearly 4% in two consecutive
days. While China took the step to reinvigorate its economy, the move has had adverse
effects across the globe.
What is devaluation?
It refers to lowering the value of a nation’s currency (here, yuan) with respect to a standard currency (the US dollar). It is done to deal with trade disparities, make exports cheaper, among other reasons.
Why did China devalue
yuan?
Growth in China’s manufacturing giants stagnated owing to
successive decline in exports and imports. In July 2015, exports declined 8.3%
year-on-year while imports also witnessed a sharp slump, falling 8.1%, after
dropping 6.1% in June. Another matter of concern was the stock market turmoil
in July 2015 that wiped out 30% of the value of shares.
A huge balance of payments deficit (i.e. payments made for
imports by a nation exceed payments received for exports, thereby causing more
outflow than inflow of currency) lead People’s Bank of China (PBOC) to sell vast
foreign exchange reserves, which kept yuan considerably overvalued, further
lowering the competitiveness of Chinese businesses.
The economic slowdown hit the Chinese economy in 2014 itself.
Efforts taken to stimulate the economy including repeated interest rate and
banks’ reserve ratio cuts, among others, did not yield expected results.
Therefore, to prevent further decline in exports and lift
the slumping economy, PBOC devalued yuan by 1.9% against the US dollar on
August 11 hoping that a weaker currency would make exports more competitive. However, experts argue that the real
intention was to set exchange rates in accordance with market practices. PBOC
called this a “one-off depreciation” but it further lowered yuan’s value the
next day, taking the total decrease to 3.5%. The move has pushed the currency to
its lowest level since the devaluation in 1994.
Global status for
yuan?
The move is also seen by some as one of Beijing’s attempts to
acquire higher status for yuan as it has been urging the International Monetary
Fund (IMF) to include the currency in the group of reserve currencies called
special drawing rights (SDR).
SDR was created by IMF to boost international liquidity by
supplementing the standard reserve currencies. Presently, this basket of
reserve currencies includes the US dollar, Japanese yen, British pound and the euro.
Across-the-board
effects
One of the thoughts doing rounds soon after the devaluation
was that the world’s second largest economy may be weaker than expected.
Besides currencies of emerging markets like Kazakhstan, Brazil, South Africa,
Turkey, etc. tumbling against the US dollar, stock markets across the world
felt the jolt. Shares of companies (car makers, luxury good firms and miners)
that export to China took a major hit. Commodity, oil and metal prices also witnessed
a steep fall.
Until the devaluation, the central bank had a tight grip on
deciding yuan’s midpoint (the average rate agreed upon when conducting foreign
exchange), which, some say, made it artificially cheap. However, from now
on the midpoint will be based on the previous day’s closing price so as to
keep the currency flexible. Nonetheless, experts assert that while China has
slightly loosened the grip, it will be quick to hold the reins if exchange
rates move in a direction unfavourable to the government.
If yuan’s value declines further (which, financial experts
believe, is likely), then economists across the globe assert that it could lead
to a currency war, with both developed and emerging economies fighting to get their
share of global consumer demand.
Impact on India
-Figures
From January to July 2015, Chinese exports to India shot up 9.7%
vis-à-vis 2014. During the same period, imports from India fell 23.1%.
This enabled China augment its trade surplus with India by 27.1% from the same year-ago
period. As competition with China has been difficult, now Indian manufacturers
will have a much tougher time maintaining a decent export figure. The textile
and chemicals sectors can feel tremendous pressure due to this competition.
-Domino effect of
problems
A few days after yuan’s devaluation, rupee fell to 66.58, its
lowest level against the dollar since 2013. Union Finance Minister Arun Jaitley was quoted
as saying that it “may have a transient impact on India.”
Many in the financial sphere fear that a falling rupee will
cause a chain reaction of problems starting with rise in petrol prices. As 80%
of India’s crude oil needs is fulfilled by imports, a weaker rupee would result
in a high import bill, which would cause oil companies to raise petrol and diesel
prices.
Pricier transport fuel would increase prices of most goods/services,
thereby fuelling inflation. This would mean that the RBI would be averse to bringing
down interest rates. Resultantly, loan payments would dig deep into people’s pocket.
Everything from luxury goods and commodities like imported gadgets
and gold to foreign education and vacations, would become costlier. Indian
companies may also feel the hit in the high-cost-low-profit scenario.
In a nutshell, going by China’s assertion that the
devaluation is according to market fundamentals as it occurred days after data
indicated a sharp decline in its exports, there are several short and long term
effects that are likely to spell trouble for world economies.
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