China Currency Devaluation and its impact

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China, in August 2015, had devalued its currency yuan against US dollar. This devaluation had sent shock waves through global markets. Analysts contended that China is devaluing its currency to improve its export competitiveness. This move, many argue, will have far-reaching ramifications for countries like India.

This devaluation was carried by the Central Bank of China because:
1. It will provide impetus to the Exports sector of China, because a weaker Yuan against dollar will result in cheaper exports.
2. In order to include Yuan as a hard currency under Special Drawing Rights(SDRs) of IMF.
Possible Impact on India:
    1. it would jeopardise the efforts made to set up NDB, contingency reserve arrangement under BRICS, and china‘s Belt Road initiative which involves  trade agreements with over 60 countries.
    2. Would lead to protectionist measures affecting India‘s exports to China. Thus indian exports would be adversely affected.
    3. China is india‘s biggest trading partner and thus a crash in their financial markets might make india a victim of domino effect thus affecting indian stock markets.
    4. Would affect China‘s investments in India‘s infrastructure sector as domestic crunch might affect funding of these projects.
    5. Might boost india‘s prospect as an alternative investment destination to China, thus inviting further foreign investments.
    6. Might start a currency war as many nations would slash their currency to protect their own exports.
Possible Impact on World:
    1. Might start a currency war
    2. Chinese export will become cheap. Will impact other exporting nations.
    3. This move has led to increase in demand for dollar, and hence weakening of currencies like Euro,Yen and Ruppee against Dollar.
Why it will not have a great impact on India?:
    • Foreigners cannot be attracted to Indian equity markets because of the poor state of the Chinese market. Foreign investors will buy Indian paper on the basis of its valuation and on the basis of macroeconomic expectations, and not because China is having a crisis
    • Yuan devaluation will have a limited impact on India’s export competitiveness because of the little overlap between the countries.
    • Yuan devaluation is too small to make a significant difference.
    • Petroleum products and jewellery account for roughly 30% of India’s exports. In contrast, over 40% of China’s exports are mechanical and electronic goods. Further, unlike India, where agricultural products account for 10% of exports, China exports little or no agricultural produce. This lack of product overlap reduces potential gains or losses on account of fluctuations in the value of the yuan.
In the light of recent devaluation of its currency by China, do you think India should also devalue its currency? Substantiate. (200 Words)
Recently china devalued yuan successively to deal with the current economic slowdown and market crash. This has spurred the debate as to whether India should follow lead and devalue the currency. The currency devaluation by India might have following repercussions:
  1. Exports boost: A cheaper rupee would make our products cheaper worldwide thus boosting our exports.
  2. Expensive imports: India has a negative balance of trade and any devaluation would make our imports expensive and this would increase the burden of payments.
  3. Cost push inflation: naturally increase in import costs would be reflected in increased price of the goods, thus increasing inflation beyond consumer‘s confidence.
  4. Investor confidence: A devaluation would adversely affect the investor confidence increasing the repatriations and withdrawals from Indian economy. Foreign investments might dry up as chances of good returns would appear bleak.
  5. Credit default: All dollar denominated debt would become expensive and might lead to defaults which would spur a domino effect and lead to further defaults due to credit creation capacity of interlinked sectors.
  6. Floating not pegged exchange rates: india follows a market determined exchange rate. A pegged exchange rate would further deteriorate investor confidence.
  7. Forex depletion: $380 billion dollars might not be enough to pay the heavier import bills which would lead to depletion of forex reserves. Approaching IMF for reserves would mean imposition of trade criteria favourable to the west wiping out the domestic production.
  8. Credit ratings: India has worked hard for stable investment ratings but a degradation in ratings would dry up foreign capital. This would also affect our further investments in infrastructure expansion and might lead to prolonged stagflation.
Thus analysing both the pros and cons, it’s better to avoid artificial devaluation Instead focus should be on increasing credit flow by slashing the interest rates, this would boost flow of capital provided inflation stays controlled. Forex reserves should only be used in case all the efforts to control real effective exchange rate fail. In addition, focus should be on structural reforms-like boosting manufacturing sectors through better regulatory framework, finances, technology, labour laws etc. This may improve the investor confidence and help us face this economic ordeal
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Currency value should be based on its underlying strength measured via REER/NEER value. Management of currency should only be done to control volatility and not as a strategy to manage exports/imports.
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The negative of Currency devaluation by china is that
    • Indian exports will come under further strain as China and India compete for several export items such as gems and jewelery, textiles etc.
    • Additionally, a slowdown in China which is one of the top five countries itself for Indian exports is not good news.
    • Fears also exist that the sharp depreciation will aid in more dumping of Chinese goods into the Indian market, hurting domestic manufacturers, which is definitely not something that would help the ‘Make in India’ campaign in any way.
    • India already has a trade deficit of US$ 48 billion with China, and this has increased about 34 per cent from what it was in 2014-15.
    • The sharp fall in the Indian rupee has already rattled stock markets and if it continues to fall, imports will becoming further more expensive, adding to inflation.
The positive is that the:
  • slowdown in China has hit global commodity markets as well due to a decline in Chinese demand.
  • Oil and gold prices have fallen, and India which is am importer of oil and gold can seek some relief through lower oil and gold prices which will help the current account deficit.
  • Lower oil prices additionally mean lower inflation rates.
Recent developments in the Chinese financial sector have raised concerns globally about another looming crisis. Critically examine what impact these developments can possibly have on India and theworld. (200 Words)
The Chinese financial sector has witnessed a sharp decline in the recent months. This has led to rise in some concerns especially after China devalued yuan twice. Their stock market declined by over 30 percent in a month. Also their exports have been sluggish because of slackening demand. Their debt has grown to 300 percent of its GDP.
Impact on India and the world:
    1. A depreciated yuan would flood the Indian markets with Chinese goods.
    2. Depreciated yuan might take it a step closer for making a reserve currency of IMF
    3. Also it would jeopardise the efforts made to set up NDB, contingency reserve arrangement under BRICS, and china’s Belt Road initiative which involves trade agreements with over 60 countries.
    4. Would lead to protectionist measures affecting India’s exports to China. Thus Indian exports would be adversely affected.
    5. China is India’s biggest trading partner and thus a crash in their financial markets might make India a victim of domino effect thus affecting Indian stock markets.
    6. Would affect China’s investments in India’s infrastructure sector as domestic crunch might affect funding of these projects.
    7. Might boost India’s prospect as an alternative investment destination to China, thus inviting further foreign investments.
    8. China might be forced to cut its defence expenditure, thus providing an opportunity to India to strengthen its hold in Indian and south china sea.
    9. Might reduce cost push inflation in India due to availability of cheaper Chinese products, but might lead to unemployment across many developed counties.
    10. Might start a currency war as many nations would slash their currency to protect their own exports.
The impact on the world-
    1. Beggar-thy-neighbour- May lead to currency wars among nations in order to compete in international market.
    2. Economic slowdown- This may lead to delayed recovery of economies dependent on exports due to stiff competition by Chinese products
    3. US federal interest rates- US federal Bank have to delay its reversal of quantitative easing monetary policy.
Thus Chinese financial crisis might have its own advantages and disadvantages for India and the entire world, but this crisis has seriously jeopardized its efforts to become a new world economic leader.
Recently China devalued its currency yuan and this step has given rise to concerns across the world. Critically examine why China has taken this step and discuss its consequences, especially for India. (200 Words)
Recently China following the ‘Managed Floating Exchange Rate’ system devalued Yuan on 2 consecutive days by 1.9% and 1% respectively.
This devaluation was carried by the Central Bank of China because:
    1. It will provide impetus to the Exports sector of China, because a weaker Yuan against dollar will result in cheaper exports.
    2. In order to include Yuan as a hard currency under Special Drawing Rights (SDRs) of IMF.
Consequences on Global World:
    1. It will make Chinese exports competitive in the global arena. It is expected that central banks of other countries might also resort to devaluation in order to boost their country’s exports. This is called as the currency war.
    2. This move has led to increase in demand for dollar, and hence weakening of currencies like Euro, Yen and Rupee against Dollar.
Consequences for India:
Positives:
  1. It will make imports of Chinese imports like electronic goods cheaper.
  2. China also acts as an exporter of some crucial raw material for India. This will provide a boost to Manufacturing sector and a growth in capital goods(machinery).
  3. If Yuan is added as a hard currency under SDR, it will increase India’s Foreign Reserves.
Negatives:
  1. China is a major exporter of steel in India. Cheaper Imports will lead to problems for the domestic steel industry.
  2. Demand for India’s exports might decline and lead to a rise in Current Account Deficit (CAD).
  3. Decreased investment and hence a slump in stock market.
  4. Will increase the trade deficit with China.
However, the government has taken steps like increasing import duties in order to protect the domestic sector and is keeping a check on Trade deficit and CAD.

 

 

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