Few days ago,China perturbed global markets by devaluing its currency (the yuan). For a naive reader like me it was very difficult to understand what did it exactly mean and Why did China do it ?
In simple words, It adjusted the value of its currency downward compared to other currencies. The country cut the currency’s value against the dollar by approx 2% which was considered as the biggest move in a decade.
This post will explain and answer the question regarding this rattling move.
Why did China devalue its currency?
The yuan has been rising in value, when it should have been falling due to slowing economic growth and lower exports. Furthermore, the currencies of other developing countries have fallen. This has hurt Chinese exporters by making their goods more expensive abroad. China is hoping that the devaluation will improve the country’s economic growth and stimulate the declining export industry. Falling exports means China runs of the risk of large-scale job losses in manufacturing industries. It does not want that to occur.
What will the devaluation mean for China?
The devaluation means Chinese products are more competitive overseas. Chinese goods will be cheaper for overseas buyers. Thus the devaluation was welcomed by factory owners in China.On the flipside, imports will be more expensive. This will impact overseas companies.
What will the devaluation mean for India?
India and China officially resumed trade in 1978. India-China bilateral trade has reached $72.3 billion in 2014-15 (exports: $11.9 billion and imports: $60.4 billion), making China India’s largest goods trading partner. The devaluation will hurt Indian companies that want to export to China by making Indian goods more expensive. However, it will be cheaper for us to import goods. This, in turn, will have a negative impact on Indian exports. Further, there will be an influx of Chinese goods into India, which will result in widening the already rising trade deficit (i.e. more Import over Export) with China.
World wide Impact of Yuan devaluation :
You can think of currency devaluation as a kind of nationwide sale. There are thousands of businesses in China that sell goods and services to customers in different foreign countries. Their goods are generally priced in China's own currency, the yuan. So if the yuan becomes less valuable relative to the dollar, Chinese imports suddenly become cheaper. In other words, when the yuan falls by 2 percent, as it has over the past few days, it's as if every business in China cut its prices for the World by 2 percent.
As sales help stores sell more of their products, a currency devaluation helps countries sell more exports, boosting the economy. Right now the Chinese economy is in the midst of an economic slowdown and has suffered from stock market turmoil, so it can use some extra help.
Of course, everything I've just said works in reverse for other countries. As the yuan gets cheaper, the other currencies get more expensive from the perspective of Chinese consumers. That means it's getting more expensive for Chinese people to import World-wide goods, so they're likely to import fewer of them. Lower demand for world-wide goods could mean slightly slower economic growth here in other countries.
For this reason, people often treat currency devaluation as a "win" for the devaluing country and a "loss" for the country whose currency gets more valuable.So, people outside China worry that further declines in the yuan could weaken economic growth outside of China.But it's important not to forget that the first-order result of a cheaper yuan is that world-wide consumers pay lower prices for Chinese goods.
Finally, I will end this discussion with the following question.
Can and should India also devalue its currency ?
The simple answer is India can not devalue its currency because the Indian Rupee exchange rate is market determined. The Rupee had been floating since 1993. The Reserve Bank of India can not devalue it like the Chinese central bank did.
The RBI can intervene in the market to sell the Indian Rupee (and buy, say US Dollar) to depreciate Indian Rupee if it thinks that Rupee is overvalued but this has consequences -
1) If the RBI target exchange rate is way off what the market thinks it should be and if market participants detect what RBI is doing then it can trade against that information and drag RBI into a potentially loss making large trade
2) A very low exchange rate will make imports more expensive thus increasing inflation. India is a net importer and had been running a high trade deficit (more imports than exports) for many years now. So an attempted "devaluation" by RBI even if successful will increase inflation
The Chinese Yuan on the other hand is pegged against a basket of currencies (with Dollar probably the most important component in the basket) and is not freely floating. Consequently the central bank has more control over its rate.
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