Yuan Devaluation and its Repercussions on Indian Financial Market

Posted in Finance Articles, Total Reads: 814 , Published on 09 October 2015

Any person associated with or following the Indian capital markets can clearly see the uncertainty and the turmoil the Indian financial markets is going through. Ask anyone, the reason would in some way or the other will be related to China.

It was August 11 this year, on what would otherwise be a normal day for the markets was not normal but the beginning of much more turbulence awaited it in the near future. The BSE 30-share index Sensex had already fallen from its all time high of 30,000 points it touched in the beginning of May and the sentiment was very positive after the election results when NDA coalition led by our honorable Prime minister Narendra modi, that the index returned a massive 30% which was spectacular by any standards and especially in Indian stock market. Sensex rose from 23000 to 30000 in a year which was historical. After a year when it was apparent that the quarterly results of companies were not up to the expectations, there was a persistent correction in the market.

Image: pixabay

Then the markets began to show some signs of recovery but amid the recovery and consolidation came the news of Chinese devaluation of Yuan. On august 11, China’s Central bank PBoC (People’s bank of China) devalued its currency by 2% and further devalued its currency for 2 more successive days and Yuan stood devalued by close to 3%. It was the largest drop in over 20 years during which Yuan had only been appreciating close to 30% against the dollar.

This led to a further correction in the Indian stock market with Sensex losing whopping 1075 points during three consecutive days from August 11 to August 13. Yuan depreciation was instigated by PBoC to provide boost to its exports which had tumbled by 8.3% in June over previous year amid concerns about slowing economy. Exports were the primary driver of massive growth of China in the past 35 years. Hence a boost was certainly needed in the form of currency devaluation because previous measures taken by the Central bank such as rate cut could did not have any effect.

And then came the big bad day for Indian markets. It was August 24th and the markets opened red and all it took was few hours into trading when panic creeped in and the markets were bleeding. Sensex crashed by about 1600 points on a single day and it was the worst crash in over 7 years and the last worse crash was during the financial meltdown of 2008 and there were no safe haven sectors which survived the crash. No one were able to pinpoint exact reason as to why smart money was employed to short sell on that day but cause was broadly attributed to the macro economic factors across the world and specifically to China.

China slowdown could be understood by looking at the commodity sector. China represents 48% of World’s market for steel with its steel production of 822.7 million tonnages in 2014 against the world crude steel production of 1665 million tonnages in 2014 according to World steel figures published by world steel association in 2015.

Devaluation of Yuan would cause and even caused up to a certain extent Steel imports to be cheaper than producing from ores domestically in India and 70% increase in steel imports in July is a testimony to that fact. This effect could be clearly seen from the dismal performance of Steel companies such as SAIL, Tata Steel and JSW Steel. Other Commodities producing companies such as Hindalco, Vedanta were also among the worst hit. But it’s also important to note that total steel capacity in India had already double to serve the future growth in sectors such as Infrastructure. And to fund that, companies had already borrowed to the tune of $50 billion in debt financed by banks and defaulting by these will also impact bank in the form of NPA’s (Non-performing Assets) which is bigger problem faced by both public as well as private sector banks in India. The recent rate cut of 50 basis points in Repo rate by RBI will act as a catalyst and comes as a short term relief to banks.

Unless China moves from investment driven growth to consumption driven growth, which its leaders are trying to achieve and China absorbs its overcapacity by itself rather than pumping its cheaply produced commodities as exports to its trading partners, it will create ripples now and then and India will definitely cannot insulate itself from the effect.

As far as what can be said is worst is not over yet and opposed to what an old adage goes, “It is not US but China when sneezes, the whole world catch cold“.

This article has been authored by Mohan Raj M from IIMB


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