Wednesday, 12 August 2015

China’s Yuan devaluation: Boon or Bane?

Given the recent turmoil in China’s stock markets amid gloomy economic outlook, investors were expecting bandwagoning from the central bank for quite some time. With volatility persisting in the markets, playing in the stock market has become a real worry for investors as it undermines the confidence of the Chinese people in the real economy and the government's ability to make policy.

In a seeming nod to such concerns, the central bank of China, in a surprise move, devalued Yuan by 2 per cent, the most in two decades, a move that could raise geopolitical tensions and cause a rout in emerging market currencies and metal commodities.

The People’s Bank of China cut its daily reference rate by a record 1.9 per cent, prompting the biggest slide in the Yuan since January 1994, signaling panic and desperation among policymakers to revive an economy that is set for its lowest growth since the 1990s.

The sudden currency devaluation announcement suggests that the situation in the Asia’s largest economy is far more serious than the policy makers and the authorities are letting out. Normally, authority institutes measures to prop up equity prices, but a radical shift toward a weaker currency indicates a worsening slowdown in the world’s second biggest economy which is set to miss its target of about 7 per cent growth in 2015.

Going forward, the depreciation of Yuan will improve the export competitiveness of China, but at the same time the effects of this downturn will be felt globally—it just may take some time. Given the fact that the global situation is not completely comfortable, China’s currency devaluation will create a headache for global economies as commodity prices including the bullion commodity would hit the other markets of the world.

Let’s peep into the immediate impact of Yuan devaluation on Indian economy:

China’s currency devaluation move sparked a rout in emerging market currencies, raising fears of an Asian currency war, with the rupee falling to two-year low of 64.78. The drop in the value of Yuan also gave a body blow to appetite for risky assets, with equities and commodities coming under selling pressure.

With the depreciation of Yuan, the Reserve Bank is set to come under pressure for further monetary easing and could be forced to take further rate cut action in coming months.

A weaker Yuan is not a simple but a complex issue that can also dent the competitiveness of Indian exports. With the drop in local currency, exports from China would become cheaper which may increase margin pressure on India's exports where we compete with China.

To sum it up, while the surprise devaluation move raises questions on the inherent strength of the Chinese economy, its sentimental impact on India and its currency amid not-so-favorable overall global economic environment cannot be ruled out.

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