17 Aug 2015 21:47 IST

What the yuan devaluation is all about

The impact of the cheaper yuan will be felt across a swathe of imports, from power equipment to auto parts

China set off a mild tremor across global markets last week when it let the yuan to go down sharply without warning. The currency fell as much as 4.8 per cent versus the dollar in just two trading days, registering its biggest fall in a single day since 1994. The yuan fell again on Thursday before recovering to end the week with a 3 per cent fall in its value.

The sudden plunge proved traumatic for the markets, used as they are to a fixed yuan-dollar relationship, with the values fluctuating, if at all, within a 2 per cent band. The yuan took down with it other currencies such as the Aussie dollar, New Zealand dollar, Indonesian rupiah and our very own rupee.

What is the yuan devaluation all about? Is it a competitive measure taken by a country whose economy is shaky? Or is it related to China’s aspirations for the yuan to join the IMF’s global reserve currency basket? These are questions troubling not just the markets but several economists and leaders of the developed world.

Consumption-driven model

China is in the process of rebalancing its economy, from an export-led one to an internal consumption-driven model. The economy has been growing at a slower pace of around 7 per cent in the last few quarters. Leaders of a number of other countries might give an arm and a leg to post such growth. But 7 per cent is low by China’s standards and, worse, comes at a time when it is attempting a soft landing for its construction and real estate sector, which is engulfed in a bubble.

Economists wonder if the devaluation is a signal of the fissures in China’s economy and whether the 7 per cent growth conceals more than it reveals. Could China be attempting to make itself more competitive by devaluing the yuan and thus making its products cheaper in the global market? The worries are actually two-fold. First, if the Chinese economy is actually weaker than it seems, it spells bad news for the global economy. China is not just a big supplier of manufactured products but a major consumer as well.

Second, if it turns out that the move was to push exports then it raises the spectre of a competitive devaluation by others affected by the move. Such a nightmarish situation, where countries engage in a “beggar thy neighbour” policy of cheapening their currencies to get a greater share of the global trade, was what prolonged the Great Depression of the 1930s. It is exactly this fear that is at the back of the minds of economists when they consider China’s actions of the last week with anxiety.

IMF requirements

China, however, has moved quickly to reassure the developed world that the devaluation was not aimed at making its exports competitive. Officials of the Peoples Bank of China, the equivalent of the Reserve Bank of India, have explained that the devaluation is aimed at making the yuan acceptable to the IMF for inclusion in the basket of reserve currencies along with the dollar, the euro, the pound and the yen. One of the complaints of the developed world against the Chinese currency is that it is fixed and not linked to the market.

Even if this explanation is true, it has the incidental effect of making Chinese products cheaper in the global market. For a country like India — grappling with slowing exports and an economy refusing to awaken from its slumber — the yuan’s devaluation is not good news.

More than in exports, where it is no match anyway to China, India will be hit on the import side. Steel producers have, even before the devaluation, been complaining of China supplying steel products to Indian buyers at throwaway prices.

Impact on imports

The government recently increased the import duty on steel products to 10 per cent to counter the alleged dumping by Chinese producers but even this small measure has been negated by the devaluation now. It is not surprising, then, that steel companies want safeguard duties to be imposed on Chinese producers.

The impact of the cheaper yuan will now be felt across a swathe of products imported into India, ranging from power plant equipment to auto components and even automobile tyres. The rupee has depreciated by about 1.5 per cent in the last one week, in sympathy with the yuan, but that will be of little comfort to importers.

Meanwhile, the Chinese situation is still developing and no one can say with certainty if the last word in the devaluation script has been acted out or if more is in store. Clearly, the whole world is shivering from China’s cold.

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