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 stronger dollar, which is not what is desirable at a time when the economy is showing 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 range of Rs 65/$ which appears to be the new benchmark.
So far the RBI has ensured that the rupee remains 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.
(The writer is chief economist at CARE Ratings. Views are personal)
