Plagued by
slowing economy, rising wages, falling exports, china has devalued its currency
to resurrect its growth. but it ended up sending shock-waves across the world.
The
devaluation of the yuan is a conscious attempt made by the People’s Bank of
China — as the central bank in that country is called — to revive the Chinese
economy which appears to moving downwards in terms of rate of growth. While the
ostensible reason given is that the currency is being aligned to the market,
the general belief is that this correction is being made to boost its exports,
which are very important for China as it accounts for around 25 per cent of
GDP.
As the
rate would be fixed to the previous day’s close, the value may be expected to
continue in the downwards direction. This move is a fairly aggressive as China
is one country which has been building its forex reserves over the years
leading to a strong case for appreciation of the yuan. It has however held on
to an undervalued currency to support growth in exports. Hence, this
devaluation has chan-ged the currency equations in the global market as it
impacts all countries. While there is a view that currency depreciation was
being driven by the fact that other currencies have depreciated through
conscious easing programmes of the central banks, this action is quite singular
as it has not been brought about by market forces but driven by the central
bank.
Such an
action has already caused currencies across the world to decline as markets
everywhere are out to protect their own currencies. The main target would be
the US where a recovering economy is witnessing a stron-ger dollar, which is
not what is desirable at a time when the economy is sho-wing growth tendencies.
This trend
is quite pernicious as it may trigger a currency war especially for exports
dependent economies where ‘not following the herd’ would mean slowdown in
exports and hence growth. This would not be a major problem for the exporting
nations when overall growth in world trade is high. But today with global trade
still at a low level, the overall size of the pie is not growing to accommodate
all such depreciation and hence there will be incentive to depreciate at a
faster rate.
The rupee
has already fallen by more than a rupee against US dollar in the trading sessions
subsequent to this devaluation as the market is guessing the right rate given
that the yuan is now expected to move towards 6.6-6.7 to a dollar in the next
few days.
The
challenges are on several fronts. First, with imports from China getting cheaper
there will be a threat to companies in sectors such as steel, textiles, auto
components etc. This can only be countered by higher duties and rupee
depreciation will not help.
Second,
exporters will be hoping for a sharper rupee depreciation as the price
advantage in the global market can be retained only if the rupee can match the
yuan fall.
Third,
companies with forex exposures will find themselves vulnerable if the
depreciation carries on or stabilises in the ran-ge of `65/$ which appe-ars to
be the new benchmark.
So far the
RBI has ensu-red that the rupee rem-ains within a band by intervening in the
market. External capital flows also helped to stabilise the balance of payments
even when other emerging market currencies depreciated faster on account of the
expected hike in Fed rate. Therefore the risk of unhedged exposures surfaces
again. Four, there can now be a strong reason for RBI to hasten the process of
lowering rates as typically we would like to see a weaker rupee which was being
countered to an extent by the FII flows into the debt segment. Lastly, RBI will
be back into business of controlling the fall in the rupee as the so-called
correct value of the rupee has to be conjectured and then attained. The yuan
fall has hence added a new dimension to global volatility which hitherto was
centred on the actions of the Federal Reserve. This shock is even more severe
as it affects trade flows that adds or subtracts to GDP growth and not just the
balance of payments as was the case when investment flows were affected
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