Decoding Yuan Devaluation, Impact on India

With China’s devaluation of yuan, the global economy is facing heat. Despite being a consumption based economy, India won’t remain untouched by the currency depreciation

Yuan Devaluation and impact on India

Yuan Devaluation and impact on India

The global economy has taken an enormous batter due to the recent cumulative currency devaluation by China. Yuan was depreciated in value by 4.4 percent, in total, over the three-day period (11-13 August), against the dollar.

Other than causing turmoil in the world economy, this yuan depreciation has raised some questions as well: why was the International Monetary Fund (IMF) unable to foresee the crisis in advance?

Actually this is not the first time that the IMF failed to anticipate a crisis. The Lehman disaster is one such example when the international funding institution was caught oblivious despite numerous economists including incumbent Reserve Bank of India (RBI) governor Raghuram Rajan proffering an adequate caveat in advance.

Sufficient Indication in Advance

The Chinese economy was constantly giving sufficient signals that it’s losing impetus which could easily follow into bothersome fluctuations in its currency. The first indication surfaced at the start of 2014 when China observed its first deceleration forcing President Xi Jinping to recognize this as “new normal” in China’s economy (Xinhua 2014).

China’s Gross Domestic Product (GDP) rate was around 7 percent in the fourth quarter of 2014 falling from 10 percent in the first half of 2011. In the first quarter of 2015, the rate of growth plummeted below even 7 percent. It presents a perfect reminder of early 2009 days when the Chinese economy was marred with economic depression.

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However, the economy recovered and soared to 7 percent growth in the subsequent quarter. According to the latest IMF estimates, the Chinese economy will grow at 6.8 percent in 2015 (IMF Survey 2015). If this proves accurate, China will be growing below 7 percent for the first time since 1991.The foremost rationale behind torpid Chinese economy is slowing down of merchandise trade. The growth was just 3.4 percent in 2014. The rate of exports was just 6 percent and imports scarcely grew in this period.

In 2015, China’s imports fell by over 7.5 percent and exports by about 4 percent in the subsequent period of last year.

Outflow of Capital

Even the Chinese capital market has not remained unscathed by downbeat sentiments. The outflow has increased in the past few months making circumstances further difficult for the government. Adjusting for adjustments in the foreign exchange reserve valuation capital outflows were in the range of $450 billion, as per JP Morgan (Bloomberg Business 2015).

In addition, the Chinese stock market also created problems. The stock market crash began with busting of the stock market bubble on 12 June, 2015. A third of the value of A-shares listed on the Shanghai Stock Exchange diluted inside one month of the incident. Key aftershocks occurred around 27 July and 24 August’s “Black Monday.”

On top of that yuan is facing an upward push following dollar appreciation. Although formal peg of “redback” with the “greenback” was removed almost 10 years ago, there exists certain sentimental correlation. In fact yuan has been pegged with the dollar through a daily reference rate set by the People’s Bank of China (PBoC) that allows it to move in a fixed band of 1 per cent on either side of the reference rate. As the dollar becomes strong, yuan is facing heat since competitiveness of the Chinese exports decreases resultantly, with an appreciation in its value. It makes China uncompetitive in the international market.

Following the recent Article IV Consultation with China, the IMF (2015a) has reported “REER (real effective exchange rate) has been on an appreciating trend since the 2005 exchange rate reform, gaining an average of 5% a year during 2006–14 (3% in 2014).”

However, as yuan now adjusts to the market levels the exports can see a rise. With this China can also prove to its detractors that its currency responds to the market forces. This can ultimately clear the path for yuan to be included in the basket of currencies used to determine the value of the special drawing rights (SDR).

What it means for India?

China is India’s largest trading partner, but the relationship is based on substantial trade imbalance. In the last ten years alone, the trade imbalance has increased almost 33 times. The figure stands at $48.5 billion from $1.4 billion in 2004-05. The reason behind this is a steep rise in terms of imports from China which were $60 billion in 2014-15 from $11 billion in 2004-05. The exports are a meagre $12 billion in 2014–15 in comparison to $5.6 billion in 2004–05. Even during the period when China was forced to appreciate its currency, the trade balance between both remained highly worrisome for India. This shows a lot still needs to be done in terms of making India highly competitive in terms of making it a significant export based economy just like it’s in IT services sector.

More than 80 percent of the total imports made by India from China in 2014 comprised largely of capital and intermediate goods. With yuan devaluation, projects that are based on supplies from China will profit notably, helping more projects to flourish. But at the same time, depreciation in the currency of China can put pressure on domestic manufacturers.

The Indian government needs to be pro-active in shielding its manufactures at this time otherwise the existing scenario doesn’t appear to bode well for Narendra Modi’s “Make in India” project. This is the right time for manufacturing reforms to arrive at the helm of affairs if India is serious in becoming an export destination for the rest of the world.

Image Source: bulawayo.com

References

http://www.epw.in/system/files/pdf/2015_50/36/Yuan_Devaluation_and_Its_Impact.pdf

http://www.theguardian.com/business/2015/aug/11/china-devalues-yuan-against-us-dollar-explainer

IMF Survey (2005)

Ashish Pandey

I am a business and finance journalist who is currently employed at Financial Express and previously at Zee News. My areas of interest include business and foreign policy. You can reach me on Twitter at @ashuvirgo1984 or @eFundsPlus.

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