Big Picture, GS-3, Indian Economy, Uncategorized

Devaluation of Chinese Yuan

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Summary:

The Chinese stock market is once again in turmoil. Added to it is the government’s decision to devalue its currency for the second time in less than six months. This has raised concerns all over the world. The impact of stock market tumbling in Shanghai has been felt all over the world. The devaluation of Yuan is bound to affect the exports of several major countries across the world.

Some analysts fear the yuan’s quickening slide suggests the world’s second-largest economy is in deepening trouble. China is one of biggest markets for many global companies. And a further economic slowdown in China, which is growing at slowest rate in decades, could impact the earnings of global corporates. However, China’s foreign exchange regulator has urged the country’s investors not to be alarmed by foreign institutions talking down the yuan, saying the currency remained relatively stable. By devaluing its currency, China gains an advantage in global trade. Its exports become cheaper, and more attractive, to foreign buyers. To stay competitive against China, its trade partners – mostly in Asia – devalue as well to maintain a cheaper currency.

The lowered Yuan forecast indicates that 2016 will be a year of continued bumpy deceleration and significant policy easing in the Chinese economy will take place. Chinese policy makers have pushed the currency lower to try and help boost the competitiveness of the country’s exporters. There is the uncertainty about when and by how much China will engineer its next round of depreciation. The new system of a managed float enables it to let the currency slip whenever it finds it imperative strategically. Besides, there is an increased ‘risk’ that the US Federal Reserve might take into account the impact of the emerging market mayhem and push back its rate lift-off from December.

There are other worries as well. Some analysts fear that, with oil prices falling, the Gulf economies will revalue their currency peg against the dollar so that each dollar of oil revenues translates into higher local currency revenue. Additionally, a weaker yuan is feared to drive the global economy closer to a recession as the purchasing power of the world’s second largest economy deteriorates every time the currency is devalued. The devaluation also affects demand for commodities and imported goods, undercutting oil and other industrial commodities. That would in turn hurt emerging-market economies like Chile and Brazil that depend on China to buy the copper and oil that they export. It would also hurt developed nations like Germany, which see China as a key growth market. Weaker commodity prices would further weigh on inflation, already stubbornly low. To top it off, if the yuan continues to decline, it could instigate a currency war as countries race to protect their exporters by devaluing in turn.

The fact that this is all happening at a time of slowing economic growth—when China’s leaders are trying to guide the economy through a difficult transition from one dependent on exports to one driven by consumption—further complicates matters. China’s currency moves also come at a critical time for the yuan: it was recently placed into the IMF’s group of elite global currencies. Few experts argue that China may not be starting a currency war. But the snowball effect of a sinking currency is picking up momentum. The concern is that it will force other countries to devalue their currencies in a tit-for-tat fashion.

Following Yuan devaluation, a number of emerging market (EM) currencies, including the rupee, fell and their stock markets came under severe strain. This devaluation has exposed the vulnerability of a number of the Asian economies that had built up massive stocks of foreign currency debt or had seen their domestic bonds being lapped up by investors in the Western world stuck with extremely low interest rates. The sharp fall in yuan has also raised fears of cheaper Chinese goods hurting the sales of domestically manufactured products in many countries.

India’s export sectors that could be affected include textiles and garments, where China has been losing competitiveness over the years. Then there is an impact on Indian firms with a China exposure. Shares of Indian metal companies have fallen sharply on concerns over cheaper Chinese imports. This devaluation is expected to make Indian exports expensive and widen the trade deficit with the neighbouring nation. There could be concerns for banking sector stocks, who are already under pressure on account of a lingering bad loans problem. Also, firms that have seen funding from Chinese entities, especially in core sectors such as power, could experience some volatility from a stock perspective. Sectors where the burden of debt is high including iron and steel, construction and telecommunications —could also see continued selling pressure in the coming months.

However, India’s big push for infrastructure development perhaps could get a boost from cheaper Chinese funds and resources. Chinese cooperation in the development of India’s high-speed rail network, renewable energy sector, smart cities and more importantly, the manufacturing sector, could become more feasible in the wake of reduced possibilities and opportunities for Chinese companies in their home country. India should cushion itself to reduce the negative impact of a Chinese slowdown. At the same time, it should also explore the positive side of a Chinese slowdown.

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