Posted in Finance Articles, Total Reads: 721
, Published on 14 December 2015
Devaluation means reduction in the exchange value of a country’s currency with respect to a foreign reference currency. It helps securing the foreign trade and tourism. The devaluating country gets less for what they are selling abroad and pay more for what they are buying abroad.
1.9% devaluation of the Chinese currency, yuan, by the People’s Bank of China (PBoC) on 11th August 2015, this downward adjustment came over 10 years after China began a process of lifting the value of its currency, which restructured its exchange rate and made yuan, one of the most actively used currencies in Asia and the second largest in the world. Devaluation led the fall in currency by one-third. This move sent fresh shockwaves through global markets. Stocks, currencies and commodities fell sharply as investors feared a possible currency war and destabilizing of world economy.
Yuan is a Managed Float whose value is determined everyday by the PBoC on the previous day’s movements. It sets a midpoint for the value of the yuan against the USD. In daily trading yuan is allowed to move by 2% above or below that midpoint which is called the daily fixing. This criteria would also be widened which would allow the currency to rise or fall more rapidly than before and make the midpoint more market based. This is different from other major currencies such as USD, Euro etc., which are freely traded.
Why did China devalue its currency?
China is going through an economic slowdown and is trying to improve its exports as it’s the epicenter of Asia in terms of exports. It exports or rather dumps approx. half of the goods it produces. By devaluating its currency by almost 4% by this month, it has made its products cheaper as compared to the products which are imported by 4%, thereby trying to improve its sales and reduce its inventory which is there due to the mass manufacturing by Chinese FMCG companies.
Impact on China:
It could be aimed at satisfying the IMF conditions for granting it Reserve Currency Status and its inclusion in the Special Drawing Rights (SDR) basket. It would raise China’s influence on the world platform and mark a major step in the international use of the Chinese currency.
China will be able to sell their products at a cheaper rate in dollar-using currencies.Devaluation will result in payment for the commodities like oil, copper etc. with cheaper yuan. It could also lead to further weakening of Chinese economy and thereby reducing the demand for commodities.
China will have to send back the money to the foreign companies operating in China in foreign currency so devalued yuan will face a blow as USD is strong and it’s going to remain stronger in the near future.
Impact on India:
India being the growth center for a year now have poised itself well to tackle despite of fall in Sensex by 1600+ points on 24th August and devaluation of rupee to a new low of 66Rs/$ since August last year. Factors like inflation, fiscal deficit, forex reserves ($380billion) which can be used for intervention, CAD of $1282.52 million in the first quarter of 2015, import of 85% of its crude requirement, falling crude prices to a new low of 45$/barrel supports fiscal deficit could be considered as supporting factors.
Indian manufacturers could feel the pinch as China already dumps their products below cost so now further renminbi depreciation will lead to further reduction in prices.
It has led to an increase in import duty on certain steel products by 2.5 percent. This is the second increase in two months. The steel industry is facing profit pressures as prices of imported steel are about 20% lesser than the domestic products.
Indian exporters will also lose out in currency competitiveness in sectors where it directly competes with China, example-textiles, chemicals, apparels etc.
Immediate impact would be on Capital inflows as continuing volatility in Chinese markets would lead to a deeper emerging markets risk-off. Sell-off in Indian bonds in the absence of any significant buying interest
Impact on US:
With China’s growth rate at 6.8% of GDP, and sold almost $107 billion in the first half of this year but in these two weeks, sell-off of almost $100billion in treasuries. China has almost $900 billion which it can use for currency intervention and increase availability of dollars in the market.
It would give a reason to the US Fed reserve to delay rising of interest rates as China’s move puts more upward pressure on the dollar, which could exacerbate if rates are raised.
The companies of US which operate in China will face the gloomy economic slowdown and their revenues will get affected.
Export oriented sectors are going to get affected as it would be much harder to export to rest of the world as the Chinese products would be much more competitive.
Strong dollar would lead to cheaper imports from rest of the world and result in lower interest rates (long term interest rates) which determine the mortgage rates, auto loan rates etc. and it’s good for the US consumers.
Impact on Rest of the world:
China is the top trading partner for most of the African countries. Some states even introduced yuan into their foreign exchange system for the selling and buying of goods. The Nigerian Central Bank had pledged between 5-10 percent of their foreign reserves in yuan in 2011. Kenya, whose port is a major gateway for Chinese goods, had plans to set up clearing house for Chinese currency. Now these countries can see pressure on their own local currencies. Asian countries like Vietnam, South Korea, Malaysia and Thailand can be considered as more vulnerable to the devaluation. In Europe, Poland and Hungary are at a higher risk. Turkey may suffer the most. This action certainly raises a question whether it would be able to shift its economy from an export-led to a domestic demand economy and provide a boost to the bleeding economy.
This article has been authored by Amit Tomar from Symbiosis Institute of Management Studies