Yuan Devaluation Conundrum

China has one of the most flourishing growth stories of mankind. The land of the dragon-acclaimed with the discovery of gunpowder, tea and silk among others-has overcome invasions, colonization and Western Supremacy to hold its position in the world. Revolutionized in 1949 as a centrally planned economy, the dragon broke out of its eggshell, pursuing the policies of economic liberalization and global integration post 1978. Since then, China has enjoyed explosive growth, making it the world’s largest. It has a mixed economy that incorporates limited capitalism within a command economy. It used to attract most of the foreign investments (~49% of the GDP), its working population was at its peak by 2012 and the technological gap between the advanced countries and China was reduced by 2015. But instead of relaxing its economy, the dragon undertook measures to further boost the economic growth which, in reality, slowed down since the double-digit rates before 2013 to approximately 6.5%-7% during the last two years.

Factors that led to Chinese slump are —

  • It is one of the most indebted nations in the world with a debt-to-GDP ratio of over 300% as on June 2019 (over US $69 trillion)
  • Longer period of cleaning bad debts because of a closed financial system
  • Global slowdown bringing down export driven demand of the Chinese manufacturing sector

Countermeasures taken by the government are—

  • Shift from manufacturing to the service sector
  • Implementation of proactive fiscal policies to increase domestic demand
  • Moving from export-oriented growth to consumer demand-oriented growth
  • Devaluation of Yuan Renminbi to boost exports

Among all other measures, the devaluation of yuan was taken as a double-edged sword. While some accused China of entering into a currency war, others felt that it might be an attempt to make a stronger case of inclusion in the IMF’s SDR basket.

Since 2005, Yuan had appreciated 33% against the US dollar. But, on August 11, 2015, the People’s Bank of China made three consecutive devaluations of its currency, knocking over 3% off its value. Many claimed it to be a desperate attempt by China to boost its exports in the slow growing economy, the PBOC claimed that the devaluation was towards making China a more market-oriented economy as committed by Xi Jinping on March 2013. In 2010, Yuan was rejected from IMF’s SDR for not being “freely usable” but the devaluation, supported by the claim of market-oriented reforms, made Yuan a part of the SDR in 2016.

The US-China trade war became murkier. Four days after Trump threatened to impose 10% tariffs on $300 billion worth Chinese imports, China decided to devalue Yuan to an eleven-year low (i.e. below 7 per dollar) on August 5, 2019. Global markets sold off on such a move, including US itself where the Dow Jones Industrial Average lost 2.9%. China was officially declared as a “currency manipulator” on August 5th, 2019. This naming opens up doors for US to consult with IMF to eliminate any unfair advantage towards Yuan.

A Slowdown in Chinese economy is bound to generate global ripples—

  • A weaker yuan makes Chinese exports cheaper. It will offset the impact of higher tariffs on Chinese imports into America. But it will also make imports into China expensive, driving up inflation and creating strains in its already slowing economy.
  • Many emerging market currencies like Turkey’s lira, Indonesia’s rupiah, South Africa’s rand, Vietnam’s dong, Brazil’s real and Mexico’s peso also weakened in value.
  • China consumes up to 50% of some raw materials, and the economic slowdown would severely impact the commodity related sector.
  • China impacts how crude oil is priced. The devaluation signaled the investors that the Chinese demand for the commodity would continue to decline as a result of which Brent Crude fell more than 20% after mid-August.
  • German companies earn 15-30% of their operating earnings and Volkswagen derives half of their total revenues from China. Semi-conductor chips, luxury goods and automobile industries are now recording a drastic fall in their sales as the Chinese turn local.

Though India has not been shackled by Yuan devaluation as some other countries, it will witness radical deep-rooted impacts. China is the biggest importer to India ($459.46 billion as on Sept, 19). These goods would now be available more economically. For India, every $1 drop in oil prices results in a $1 billion decline in the country’s oil import bill.

India will also benefit from the influx of investors who otherwise would have invested in China. With the slump in China, the turmoil in EU and the instability in Latin America, India is gaining in opportunity costs. With 100% FDI being allowed in defence, coal and aviation, foreign investments are sure to come in. India has also jumped up 14 positions from 77 to 63 in the “ease of doing business” rankings showcasing signs of improvements.

However, if India does not grab on these advantages presented by the Chinese slump, the very boon of the devalued yuan could be its bane. As a result of Yuan devaluation, demand for dollars surged around the globe, including in India, where investors bought into the safety of dollar at the expense of INR. The INR immediately plunged to a two-year low against the dollar. The threat of greater market risk led to increased volatility in Indian bond markets, which triggered further weakness for INR.

Also, with reduced commodity prices, Chinese producers can dump Indian markets with their products which has been a case in the textile, metals and chemical industries. China is also a major importer of Indian goods. The economic slump will, thus, be a major blow to the Indian trade deficit.

What India can do best now is utilize the benefits available from the Chinese slump for increasing its growth and development potential. A medley of opportunities presented before India by the ageing Chinese dragon can be realized if and only if it focuses on the development of all the sectors, reduction of inequalities and improvement in the standard of living of people which will be helping India to grow and prosper in the long run.

Harsh Goyal ( PGP 1 Section 6 )

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