A project report on devaluation of chinese currency yuan

DEVALUATION

OF

CHINESE CURRENCY (YUAN)

Project Report

Submitted By:Rohit Banskota

Santosh Adhikari

BBA 6th Semester

Padmashree International College,

Tinkune, Kathmandu.

Submitted To:Office of the Dean

Faculty of Management

Panjub Techincal University, Jalandhar,India.

In the partial fulfillment of the requirement for the degree of

Bachelor in Business Administration (BBA)

Kathmandu, Nepal

September, 2015

ACKNOWLEDGEMENT

We have taken efforts in this project. However, it would not have been possible without the

kind support and help of many individuals and organizations. we would like to extend our

sincere thanks to all of them.

We are highly indebted to Padmashree Intl’ College for providing us such an opportunity to

research and submit the report on Devaluation of Yuan (Chinese currency), which is very

much useful for us at present in getting to know about it and for our future endevours as

well. We would like to express our special gratitute towards our co-ordinator, Mr. Dilip

Verma & Mr. Ananda Ghimire for his support and encouragement which helped us in

completion of this project on time.

Moreover, our thanks and appreciations also go to our parents, colleagues in developing the

project and people who have willingly helped us with their abilities.

ABSTRACT

China devalued its currency in a way that left it 1.9% weaker versus the U.S. dollar. The

move will likely have affect in financial markets as well as in politics, as China is the

world’s largest trader to export goods and services and the Yuan is increasingly used

overseas.

Chinese Government wants to bring the Yuan more in line with the market. But the move

also comes as China’s important export sector has weakened and overall economic growth

looks sluggish. Over the weekend, According to the Chinese customs officials the exports

fell 8.3% compared with a year ago. Hence devaluating currency (Yuan) helps China’s

exporters sell their goods abroad, leading economic balance & make their currency

dominant against the US dollar.

To understand the fundamental roles, nature behind the devaluation and its effects to

Chinese and Global market, it is necessary to understand the core characteristics and policies

implemented by the Government and financial institution.

TABLE OF CONTENTS

Acknowledgements……………………………………………………………..2

Table of contents………………………………………………………………..3

List of tables…………………………………………………………………….4

List of figure…………………………………………………………………….5

Abbreviations…………………………………………………………………...6

CHAPTER ONE.1.0 Introduction……………………………………………………………..9

1.1. Background……………………………………………………………..9

1.2. Problem Statement……………………………………………………..11

1.3 Objectives of the study…………………………………………………11

1.4 Limitation of the Research……………………………………………..12

2.0 CHAPTER TWO…………………………………………………………..13

Literature review…………………………………………………………13

2.1 Background ……………………………………………………………..13

2.2 Currency …………………………………………………………………16

2.3 Exchange and Exchange Rate……………………………………………17

2.4 Exchange rate Determination. ..................................................................18

2.4.1 Fixed Exchange Rate………………………………………...18

2.4.2 Floating Exchange Rate……………………………………....18

2.5 Moment of Exchange rate…………………………………………………..18

2.5.1 Appreciation and Depreciation……………………………….18

2.5.2 Devaluation and Revaluation…………………………………19

2.6 causes the fluctuation in currency value………………………………………19

2.6.1 Changes in the imports and exports of the country……………..19

2.6.2 Changes in Interest rate:………………………………………..19

2.6.3 Changes in Inflation rate:……………………………………….19

2.7 Exchange rate policy:…………………………………………………………...19

2.8 How exchange rates are manipulated……………………………………………20

2.8.1 Effects of a reduction in the exchange rate…………………….20

2.8.2 Cost push inflation……………………………………………...21

2.8.3 Evaluation of exchange rate policy:…………………………….21

2.9 How Countries Devalue Their Currencies:……………………………………….22

2.10 Devaluation of currency from the prospective of China's:……………………...27

2.10.1 The People's Currency………………………………………....27

2.11. Why China's currency has two names?...............................................................28

2.11.1 Silver dollars…………………………………………………..29

2.11.2 Jiao and mao………………………………………………….30

2.12. China's exchange rate policy……………………………………………….…..31

2.12.1 Reasons for a stable exchange rate……………………………31

2.12.2 By-products of a fixed exchange rate………………………...31

2.12.3 Effects from sterilized intervention…………………………..32

2.12.4 Past exchange rate policy……………………………………..32

2.13 Devaluation of Yuan for the first time in two decades, and why it matters…....33

2.13.1 Who decide that the Yuan is worth…………………………...33

2.13.2 How is the Yuan's value controlled...........................................34

2.13.3 What’s changed about how the Yuan is valued........................34

2.13.4 What will happen next...............................................................35

2.14 Why China Currency Crises Matter….................................................................35

2.14.1. It could be serious…………………………………………….35

2.14.2 A less costly Christmas……………………………………….36

2.14.3 Cheaper petrol at the pump…………………………………..36

2.14.4 Delayed rate rises…………………………………………….37

2.14.5 Deflation, deflation, deflation……………………………….37

2.14.6. Tough times for Oz…………………………………………..37

2.14.7. Even more pain for Greece………………………………….37

2.14.8. Currency wars……………………………………………….37

2.15 What China's Yuan move means for emerging markets……………………...39

2.16 Opportunities for Investors……………………………………………………40

3. CHAPTER – THREE

Methodology of research………………………………………………………….43

3.1 Methodology……………………………………………………………………43

3.2 Objective of Research…………………………………………………………...43

3.3 Data Collection Method…………………………………………………………44

3.4 Limitation………………………………………………………………………..44

4. CHAPTER- FOUR

Analysis……………………………………………………………………………45

4.1. Background …………………………………………………………………....45

2.14 Why China Currency Crises Matter….................................................................35

2.14.1. It could be serious…………………………………………….35

2.14.2 A less costly Christmas……………………………………….36

2.14.3 Cheaper petrol at the pump…………………………………..36

2.14.4 Delayed rate rises…………………………………………….37

2.14.5 Deflation, deflation, deflation……………………………….37

2.14.6. Tough times for Oz…………………………………………..37

2.14.7. Even more pain for Greece………………………………….37

2.14.8. Currency wars……………………………………………….37

2.15 What China's Yuan move means for emerging markets……………………...39

2.16 Opportunities for Investors……………………………………………………40

3. CHAPTER – THREE

Methodology of research………………………………………………………….43

3.1 Methodology……………………………………………………………………43

3.2 Objective of Research…………………………………………………………...43

3.3 Data Collection Method…………………………………………………………44

3.4 Limitation………………………………………………………………………..44

4. CHAPTER- FOUR

Analysis……………………………………………………………………………45

4.1. Background …………………………………………………………………....45

LIST OF FIGURE

2.1 Import and export Relationship……………………………………………………2.1

2.2 Cost and inflation Relationship……………………………………………………2.2

2.3. Top Gainer and loser on currency in Global Market……………………................2.3

LIST OF TABLE

1.1 Short Description of China……………………………………………………….1.1

LIST OF FIGURE

2.1 Import and export Relationship……………………………………………………2.1

2.2 Cost and inflation Relationship……………………………………………………2.2

2.3. Top Gainer and loser on currency in Global Market……………………................2.3

LIST OF TABLE

1.1 Short Description of China……………………………………………………….1.1

ABBREVIATIONS

PRC People's Republic of China

ROC Republic of China

PPP Purchasing power parity

GDP Gross domestic product

U.N. United Nations

WTO World Trade Organization

APEC Asia-Pacific Economic Cooperation

BRICS Brazil, Russia, India, China and South Africa

BCIM Bangladesh–China–India–Myanmar Forum for Regional

G-20 The Group of Twenty.

RMB Renminbi

MPC Monetary Policy Committee

UK exports United Kingdom export

EMS – ERM European Monetary System

FDI Foreign Direct Investment

IMF International Monetary Fund

PBoC People’s Bank of China

MSCI Morgan Stanley Capital International

CHAPTER - ONE

INTRODUCTION

1.1. Background

China, officially the People's Republic of China (PRC), is a sovereign state in East Asia. It is

the world's most populous country, with a population of over 1.35 billion. The PRC is a

single-party state governed by the Communist Party of China, with its seat of government in

the capital city of Beijing. It exercises jurisdiction over 22 provinces, five autonomous

regions, four direct-controlled municipalities (Beijing, Tianjin, Shanghai and Chongqing),

and two mostly self-governing special administrative regions (Hong Kong and Macau). The

PRC also claims the territories governed by the Republic of China (ROC), a separate

political entity today commonly known as Taiwan, as a part of its territory, which includes

the island of Taiwan as Taiwan Province, Kinmen and Matsu as a part of Fujian Province

and islands the ROC controls in the South China Sea as a part of Hainan Province and

Guangdong Province. These claims are controversial because of the complex political status

of Taiwan.

Covering approximately 9.6 million square kilometers, China is the world's second-largest

country by land area, and either the third or fourth-largest by total area, depending on the

method of measurement. China's landscape is vast and diverse, ranging from forest steppes

and the Gobi and Taklamakan deserts in the arid north to subtropical forests in the wetter

south. The Himalaya, Karakoram, Pamir and Tian Shan mountain ranges separate China

from South and Central Asia. The Yangtze and Yellow Rivers, the third- and sixth-longest

in the world, run from the Tibetan Plateau to the densely populated eastern seaboard. China's

coastline along the Pacific Ocean is 14,500 kilometres (9,000 mi) long, and is bounded by

the Bohai, Yellow, East and South China Seas.

China is considered a cradle of civilization, with its known history beginning with an ancient

civilization – one of the world's earliest – that flourished in the fertile basin of the Yellow

River in the North China Plain. For millennia, China's political system was based on

hereditary monarchies, known as dynasties, beginning with the semi-mythological Xia of the

Yellow River basin (c. 2800 BCE). Since 221 BCE, when the Qin Dynasty first conquered

several states to form a Chinese empire, the country has expanded, fractured and been

reformed numerous times. The Republic of China (ROC) overthrew the last dynasty in 1911,

and ruled the Chinese mainland until 1949. After the surrender of the Empire of Japan in

World War II, the Communist Party defeated the nationalist Kuomintang in mainland China

and established the People's Republic of China in Beijing on 1 October 1949, while the

Kuomintang relocated the ROC government to its present capital of Taipei.

China had the largest and most complex economy in the world for most of the past two

thousand years, during which it has seen cycles of prosperity and decline. Since the

introduction of economic reforms in 1978, China has become one of the world's fastest-

growing major economies. As of 2014, it is the world's second-largest economy by nominal

total GDP and largest by purchasing power parity (PPP). China is also the world's largest

exporter and second-largest importer of goods. China is a recognized nuclear weapons state

and has the world's largest standing army, with the second-largest defence budget. The PRC

has been a United Nations member since 1971, when it replaced the ROC as a permanent

member of the U.N. Security Council. China is also a member of numerous formal and

informal multilateral organizations, including the WTO, APEC, BRICS, the Shanghai

Cooperation Organization, the BCIM and the G-20. China is a great power and a major

regional power within Asia, and has been characterized as a potential superpower by a

number of commentators.

Table 1.1 Short Description of China

1.2. Problem Statement

China’s central bank devalued the country’s currency, the Yuan, by 1.9% against the U.S.

dollar. It was the biggest one-day move since the Renminbi, or Yuan, officially de-pegged

from the U.S. dollar in 2005. The Yuan maintains a close relationship with the dollar and

trades 2% in each direction from a midpoint selected by China. Today, that midpoint went

from 6.11 Yuan per U.S. dollar to 6.22.

Trump and others may say China is purposely devaluing its currency to help exports. After

all, its economy is struggling to hit the government 7% growth target. But is that what’s

really going on?

For the most part, China has recently actually wanted its currency to steadily rise, for

political reasons and to keep capital from flowing out of China. China’s domestic and

international goals align with a stronger Yuan. That helps explain why presidential

candidates like Trump haven’t been spouting off about China’s currency management as

much of late.

Capital Beijing

Largest City SahangaiOfficial languages Standard Chinese

Government Socialist single-party state

Legislature National People's Congress

Area 9,596,961 km2

GDP $11.212 trillion

Per capita income $8,154

Currency Yuan & Renminbi ( $1= 6.17

The answer to why China’s government devalued its currency is probably has more to do

with the dynamics of global currency markets than a sudden urge to help Chinese exporters

make their goods cheaper on the world market.

First, the Yuan is strongly related to the dollar because China still manages the exchange

rate within a range against the dollar. When the U.S. dollar rises rapidly against world

currencies, like it has in the past year to pull almost even with the euro, the Yuan also rises

against China’s trading partners’ currencies.

1.3. Objectives of the Study

The objectives of the study are:

To know about the overall activities of Chinese Government regarding the

devaluation of currency and its Economic policies.

Impact of devaluation of Yuan in Global Market.

China's exchange rate policy

1.4. Limitation of the Research

• The study is done for the academic purpose so it is done with limited time.

• These studies carry the information of China only So its findings are not applicable

for other countries and for other events.

• A study is based on the secondary data, which is not sufficient for completion of

study.

• The statistical tools used in research are also creates limitation.

• Devaluation is the results of different factors it creates impacts on different factors.

But this study is based on limited factors only.

CHAPTER – TWO

LITERATURE REVIEW

2.1. Background:

The Chinese Yuan is the latest currency in a very colorful history. China was one of the first nations

on earth to create currency to take the place of barter. The first coins, made from bronze and cast

into molds, were made around the 4th century BC in central China. These coins had a round hole in

the middle so that they could be kept on strings. Nearly a century later the first emperor of China,

Shi Huangdi, changed that to a square hole. The design did not change for the next 2,000 years.

Before the Yuan, China experimented with paper money around 910 AD during the Five Dynasties

period. The famous explorer Marco Polo marveled at the paper currency, stating that the emperor

could print enough money to buy all the goods in the world at no cost to himself. Paper money was

also used in Szechwan, an area that experienced frequent copper shortages and reverted to a currency

based on iron.

Much later, in 1889, the Yuan was introduced as a silver coin derived from the Spanish dollar

(peso). The peso had been widely circulated in South East Asia since the 1600’s because of the

Spanish presence in nearby Guam and the Philippines. The Yuan replaced copper cash and silver

ingots called Sycees. Around that same time the Yuan was also issued in banknotes.

In 1903 the government started issuing other coins in the Yuan currency system. These were brass 1

cash, copper coins in the denominations of 2, 5, 10 and 20 and silver coins in 1, 2, and 5 cash. The

sizes of the coins and metals used did not change after the revolution but stayed the same until the

1930’s when nickel and aluminum coins were introduced.

The modern Chinese Yuan is also called the Renminbi (RMB) which translates as “the peoples’

currency”. It was first issued by the Chinese Communist Party’s People’s Bank of China in

December of 1948. At that time, China was involved in a civil war between the Communist Party

and the Nationalists. At the close of that conflict the communists won the mainland and had to

address the high inflation the country’s economy was saddled with. Thus, 1955 a second series

of Yuan was issued that replaced the old Yuan at a rate of 10,000 old Yuan to one new Yuan. The

economy was stabilized and the country entered a new age with high hopes.

And recently China’s central bank devalued the country’s currency, the renminbi, by 1.9%

against the U.S. dollar. It was the biggest one-day move since the renminbi, or Yuan,

officially de-pegged from the U.S. dollar in 2005. The Yuan maintains a close relationship

with the dollar and trades 2% in each direction from a midpoint selected by China. Today,

that midpoint went from 6.11 Yuan per U.S. dollar to 6.22.

Trump and others may say China is purposely devaluing its currency to help exports. After

all, its economy is struggling to hit the government 7% growth target.

China has recently actually wanted its currency to steadily rise, for political reasons and to

keep capital from flowing out of China. China’s domestic and international goals align with

a stronger Yuan. That helps explain why presidential candidates like Trump haven’t been

spouting off about China’s currency management as much of late.



make their goods cheaper on the world market.

First, the Yuan is strongly related to the dollar because China still manages the exchange

rate within a range against the dollar. When the U.S. dollar rises rapidly against world

currencies, like it has in the past year to pull almost even with the euro, the Yuan also rises

against China’s trading partners’ currencies.

China has wanted the Yuan to steadily rise against trade-weighted partners for a while. To

keep that appreciation gradual, as the dollar rockets upwards, it may have to devalue a little,

says Jonathan Anderson, at Emerging Advisors Group, one of the clearest observers of

China’s markets. “But this is not the same as a “competitive devaluation” of the Renminbi

and there’s nothing like that on the cards,” he wrote .

“All China is doing today is managing the pace of trade-weighted Renminbi

appreciation,” Anderson continued. “Any attempt to gain truly meaningful competitiveness

vis-à-vis trading partners would require, say, a 20% to 40% devaluation against the dollar.”

If China had devalued the Yuan by, say, 20%, it would clearly be an effort to boost exports

for its advantage. A 2% devaluation is different: it simply keeps the Yuan a little more in

line with trading partners’ currencies, which have lost value relative to the U.S. dollar.

As mentioned, China actually wants a stronger currency. As recently as April, it was

actively trying to strengthen the Yuan, the Wall Street Journal reported. The country’s

central bank purchased the Yuan in the currency markets and sold U.S. dollar holdings, a

move aimed at stemming capital outflows from China as the Yuan was falling.

As Chen Long of Gavekal Dragonomics in Hong Kong recently explained, China has twin

(and sometimes competing) goals for exchange rates. On the domestic front, it wants to help

exporters with a cheaper currency, but it also wants to maintain a strong currency to prevent

capital outflows that may weaken the country’s economy further. On the international side,

China wants to avoid a trade war with the U.S., which it would have if it severely weakened

the currency. It also wants to boost international use of the Yuan for political purposes, as

China asserts itself more strongly around the world. The country’s recent campaign to have

the Yuan join the mostly meaningless IMF reserve currency is one example of China

desiring a strong currency. In the end, these multiple goals again promote a slightly stronger

currency.

China’s central bank said, Yuan depreciation was a way to make the country’s financial

system more market-oriented. The bank said market spot prices would now determine the

daily position, implying that the central bank would step in less to influence it. Over the past

few months the Yuan-dollar spot price had been lower than the exchange rate, and it became

clear the central bank was supporting a stronger Yuan.

There are reasons the government doesn’t deserve the benefit of the doubt when it says it’s

in the business of market-based approaches. President Xi Jinping’s administration said the

same thing before pledging around $800 billion in government money last month to prop up

the falling stock market. China’s words and actions don’t always match.

But there are also reasons that today’s devaluation shouldn’t only be viewed through the

prism of trade. First, other exporters in Asia, including South Korea and Taiwan, are hurting

because of weak demand abroad. Sluggish economies in Europe and the U.S. influence

China’s exports. That’s not all solved by currency devaluations. Second, China can use other

mechanisms to boost its economy. Internet rates and bank reserve requirements can still be

cut considerably, and analysts expect that to happen. More government spending is already

in the works: China’s banks will issue 1 trillion Yuan worth of bonds for infrastructure

spending, according to recent reports.For now, it’s too early to say China is starting a

currency war, even if that may be the West’s first inclination.

2.2 Currency

Currency refers to money in any form when in actual use or circulation as a medium of

exchange, especially circulating banknotes and coins. A more general definition is that a

currency is a system of money (monetary units) in common use, especially in a

nation. Under this definition, British pounds, U.S. dollars, China Yuan and European Euros

are examples of currency. These various currencies are stores of value, and are traded

between nations in foreign exchange markets, which determine the relative values of the

different currencies. Currencies in this sense are defined by governments, and each type has

limited boundaries of acceptance.

Currencies can be classified into two monetary systems: fiat money and commodity money,

depending on what guarantees the value (the economy at large vs. the government's physical

metal reserves). Some currencies are legal tender in certain jurisdictions, which means they

cannot be refused as payment for debt. Others are simply traded for their economic

value. Digital currency arose with the popularity of computers and the Internet.

A generally accepted form of money, including coins and paper notes, which is issued by a

government and circulated within an economy. Used as a medium of exchange for goods

https://en.wikipedia.org/wiki/Internet

https://en.wikipedia.org/wiki/Digital_currency

https://en.wikipedia.org/wiki/Legal_tender

https://en.wikipedia.org/wiki/Commodity_money

https://en.wikipedia.org/wiki/Fiat_money

https://en.wikipedia.org/wiki/Monetary_system

https://en.wikipedia.org/wiki/Coin

https://en.wikipedia.org/wiki/Medium_of_exchange

https://en.wikipedia.org/wiki/Medium_of_exchange

https://en.wikipedia.org/wiki/Money

and services, currency is the basis for trade. Investors often trade currency on the foreign

exchange market, which is one of the most heavily traded markets in the world.

2.3 Exchange and Exchange rate

An act of giving one thing and receiving another (especially of the same kind) in return. A

business that allows customers to exchange one currency for another currency. A currency

exchange may be a stand-alone business or may be part of the services offered by a bank or

other financial institution. The currency exchange profits from its services either through

adjusting the exchange rate or taking a commission.

The price of a nation’s currency in terms of another currency. An exchange rate thus has two

components, the domestic currency and a foreign currency, and can be quoted either directly

or indirectly. In a direct quotation, the price of a unit of foreign currency is expressed in

terms of the domestic currency. In an indirect quotation, the price of a unit of domestic

currency is expressed in terms of the foreign currency. An exchange rate that does not have

the domestic currency as one of the two currency components is known as a cross currency,

or cross rate. Also known as a currency quotation, the foreign exchange rate or forex rate.

An exchange rate has a base currency and a counter currency. In a direct quotation, the

foreign currency is the base currency and the domestic currency is the counter currency. In

an indirect quotation, the domestic currency is the base currency and the foreign currency is

the counter currency.

Most exchange rates use the US dollar as the base currency and other currencies as the

counter currency. However, there are a few exceptions to this rule, such as the euro and

Commonwealth currencies like the British pound, Australian dollar and New Zealand dollar.

Exchange rates for most major currencies are generally expressed to four places after the

decimal, except for currency quotations involving the Japanese yen, which are quoted to two

places after the decimal.

2.4 Exchange Rate Determination:

Exchange rate could be determine through a) Fixed Exchange Rate

` b) Floating Exchange Rate.

2.4.1 Fixed Exchange Rate:

A fixed exchange rate system refers to the case where the exchange rate is set and

maintained at same level by the government irrespective of the market forces.

2.4.2 Floating Exchange Rate:

Floating exchange rate system means that the exchange rate is allowed to fluctuate

according to the market forces without the intervention of the Central bank or the

government.

2.5 Moment of Exchange rate:

2.5.1 Appreciation and Depreciation

The exchange rate for any currency usually fluctuates. When the value of the currency goes

up as compared to other currency it is known as appreciation.

When the value of currency falls as compared to other currency it is known as depreciation.

Usually the exchange rates are determined by the demand and supply of that currency in the

international market.

Demand for any country’s currency on the foreign exchange market is determined by

demand for that country’s exports of goods and services and by changes in foreign

investment in that country. This is because when foreigners buy another country’s exports of

goods or services they must pay for these in the currency of the exporting country.

In the same way Supply of any country’s currency on the foreign exchange market is

determined by that country’s imports of goods and services and by its investment in other

countries.

Thus when the demand for a currency rises its price goes up and it becomes costlier.

2.5.2 Devaluation and Revaluation:

Devaluation is a deliberate downward adjustment to the value of a country's currency, relative to

another currency, group of currencies or standard. Devaluation is a monetary policy tool of countries

that have a fixed exchange rate or semi-fixed exchange rate. It is often confused with depreciation,

and is in contrast to revaluation.

Revaluation is the official increase in the price of the currency within a fixed exchange rate

system.

2.6 What causes the fluctuation in currency value?

2.6.1 Changes in the imports and exports of the country

An increase in exports of a country will lead to an increase in demand for the currency and

thus the value rises.

2.6.2 Changes in Interest rate

Higher interest rate will attract more foreign investors to invest in the country and thus the

demand for currency will rise, resulting in appreciation in value of the currency.

2.6.3 Changes in Inflation rate

Higher inflation rate will make the country uncompetitive in the international market. The

exports will fall resulting in decreased demand for the currency and hence lower value.

2.7 Exchange rate policy

The exchange rate of an economy affects aggregate demand through its effect on export and import

prices, and policy makers may exploit this connection.

Deliberately altering exchange rates to influence the macro-economic environment may be regarded

as a type of monetary policy. Changes in exchanges rates initially work their way into an economy

via their effect on prices. Therefore, whenever the exchange rate changes there will be a double

effect, on both import and export prices. Changes in import and export prices will lead to changes in

import and export volumes, causing changes in import spending and export revenue.

Exchange rates can be manipulated so that they deviate from their natural equilibrium rate. To

stimulate exports, rates would be held down, and to reduce inflationary pressure rates would be kept

http://www.economicsonline.co.uk/Competitive_markets/The_foreign_exchange_market.html

http://www.economicsonline.co.uk/Managing_the_economy/Monetary-policy.html

http://www.economicsonline.co.uk/Managing_the_economy/Aggregate_demand.html

up. While the Bank of England does not specifically target the exchange rate, the Monetary Policy

Committee (MPC) will take exchange rates into account. Clearly, the MPC would prefer a relatively

high rate, as this reduces the price of imports and works against inflationary pressure. However, the

MPC must keep an eye on export competitiveness, and, if rates rise excessively, UK exports will

become uncompetitive.

2.8 How exchange rates are manipulated

Exchange rates can be manipulated by buying or selling currencies on the foreign exchange

market. To raise the value of the Yuan the Bank of China buys Yuan, and to lower the value,

it sells Yuan. Rates can also be manipulated through interest rates, which affect the demand

and supply of Sterling via their effect on inflows of hot money. Altering exchange rates is

commonly regarded as a type of monetary policy.

2.8.1 Effects of a reduction in the exchange rate

Assuming the economy has an output gap, a reduction in the exchange rate will reduce

export prices, and, assuming demand is elastic, export revenue will increase.

Figure 2.1

Import and Export Relationship

A fall in the exchange rate will also raise import prices, and assuming elasticity of demand,

import spending will fall. The combined effect is an increase in AD and an improvement in

the Yuan balance of payments.

http://www.economicsonline.co.uk/Managing_the_economy/Balance_of_payments_answer.html

http://www.economicsonline.co.uk/Managing_the_economy/Monetary-policy.html

2.8.2 Cost push inflation

A fall in the exchange rate is inflationary for a second reason - the cost of imported raw

materials adds to production costs and creates cost-push inflation.

Figure 2.2

Cost and Inflation

2.8.3 Evaluation of exchange rate policy:

The main advantage of manipulating exchange rates is that, because a large share of China

output is traded internationally, changes in exchange rates will have a powerful effect on

AD. For example, lowering exchange rates, called devaluation, can:

1. Raise aggregate demand

2. Increase national output (GDP)

3. Create jobs, amplified through the multiplier effect

4. In addition, assuming the demand for imports and exports are price sensitive

(price elastic), devaluation will lead to an improvement in the balance of payments-

although this can also lead to inflation

Alternatively, raising exchange rates (revaluation) can:

1. Help reduce excessive aggregate demand

2. Keep inflation down

3. Although the export sector may suffer and jobs might be lost.

http://www.economicsonline.co.uk/Managing_the_economy/Inflation_and_deflation.html

http://www.economicsonline.co.uk/Competitive_markets/Price_elasticity_of_demand.html

http://www.economicsonline.co.uk/Managing_the_economy/The_multiplier_effect.html

http://www.economicsonline.co.uk/Managing_the_economy/Aggregate_demand.html

http://www.economicsonline.co.uk/Global_economics/The_pattern_of_trade.html

http://www.economicsonline.co.uk/Managing_the_economy/Inflation_and_deflation.html

2.9 How Countries Devalue Their Currencies:

Countries devalue their currencies only when they have no other way to correct past

economic mistakes - whether their own or mistakes committed by their predecessors.

The ills of devaluation are still at least equal to its advantages.

True, it does encourage exports and discourage imports to some extents and for a limited

period of time. As the devaluation is manifested in a higher inflation, even this temporary

relief is eroded.

A government can be forced into devaluation by an ominous trade deficit. Thailand, Mexico,

the Czech Republic - all devalued strongly, willingly or unwillingly, after their trade deficits

exceeded 8% of the GDP. It can decide to devalue as part of an economic package of

measures which is likely to include a freeze on wages, on government expenses and on fees

charged by the government for the provision of public services. This, partly, has been the

case in Macedonia. In extreme cases and when the government refuses to respond to market

signals of economic distress - it may be forced into devaluation. International and local

speculators will buy foreign exchange from the government until its reserves are depleted

and it has no money even to import basic staples and other necessities.

Thus coerced, the government has no choice but to devalue and buy back dearly the foreign

exchange that it has sold to the speculators cheaply.

In general, there are two known exchange rate systems: the floating and the fixed.

In the floating system, the local currency is allowed to fluctuate freely against other

currencies and its exchange rate is determined by market forces within a loosely regulated

foreign exchange domestic (or international) market. Such currencies need not necessarily

be fully convertible but some measure of free convertibility is a sine qua non.

In the fixed system, the rates are centrally determined (usually by the Central Bank or by the

Currency Board where it supplants this function of the Central Bank). The rates are

determined periodically (normally, daily) and revolve around a "peg" with very tiny

variations.Life being more complicated than any economic system, there are no "pure

cases".

Even in floating rate systems, Central banks intervene to protect their currencies or to move

them to an exchange rate deemed favorable (to the country's economy) or "fair". The

market's invisible hand is often handcuffed by "We-Know-Better" Central Bankers. This

usually leads to disastrous (and breathtakingly costly) consequences. Suffice it to mention

the Pound Sterling debacle in 1992 and the billion dollars made overnight by the

arbitrageur-speculator Soros - both a direct result of such misguided policy and

hubris.Floating rates are considered a protection against deteriorating terms of trade.

If export prices fall or import prices surge - the exchange rate will adjust itself to reflect the

new flows of currencies. The resulting devaluation will restore the equilibrium.

Floating rates are also good as a protection against "hot" (speculative) foreign capital

looking to make a quick killing and vanish. As they buy the currency, speculators will have

to pay more expensively, due to an upward adjustment in the exchange rates. Conversely,

when they will try to cash their profits, they will be penalized by a new exchange rate.

So, floating rates are ideal for countries with volatile export prices and speculative capital

flows. This characterizes most of the emerging economies (also known as the Third World).

It looks surprising that only a very small minority of these states has them until one recalls

their high rates of inflation. Nothing like a fixed rate (coupled with consistent and prudent

economic policies) to quell inflationary expectations. Pegged rates also help maintain a

constant level of foreign exchange reserves, at least as long as the government does not stray

from sound macro-economic management. It is impossible to over-estimate the importance

of the stability and predictability which are a result of fixed rates: investors, businessmen

and traders can plan ahead, protect themselves by hedging and concentrate on long term

growth.

It is not that a fixed exchange rate is forever. Currencies - in all types of rate determination

systems - move against one another to reflect new economic realities or expectations

regarding such realities. Only the pace of changing the exchange rates is different.

Countries have invented numerous mechanisms to deal with exchange rates fluctuations.

Many countries (Argentina, Bulgaria) have currency boards. This mechanism ensures that

all the local currency in circulation is covered by foreign exchange reserves in the coffers of

the Central bank. All, government, and Central Bank alike - cannot print money and must

operate within the straitjacket.

Other countries peg their currency to a basket of currencies. The composition of this basket

is supposed to reflect the composition of the country's international trade. Unfortunately, it

rarely does and when it does, it is rarely updated (as is the case in Israel). Most countries peg

their currencies to arbitrary baskets of currencies in which the dominant currency is a "hard,

reputable" currency such as the US dollar. This is the case with the Thai baht.In Slovakia the

basket is made up of two currencies only (40% dollar and 60% DEM) and the Slovak crown

is free to move 7% up and down, around the basket-peg.

Some countries have a "crawling peg". This is an exchange rate, linked to other currencies,

which is fractionally changed daily. The currency is devalued at a rate set in advance and

made known to the public (transparent). A close variant is the "crawling band" (used in

Israel and in some countries in South America). The exchange rate is allowed to move

within a band, above and below a central peg which, in itself depreciates daily at a preset

rate. This pre-determined rate reflects a planned real devaluation over and above the

inflation rate. It denotes the country's intention to encourage its exports without rocking the

whole monetary boat. It also signals to the markets that the government is bent on taming

inflation.

So, there is no agreement among economists. It is clear that fixed rate systems have cut

down inflation almost miraculously. The example of Argentina is prominent: from 27% a

month (1991) to 1% a year (1997).

The problem is that this system creates a growing disparity between the stable exchange rate

- and the level of inflation which goes down slowly. This, in effect, is the opposite of

devaluation - the local currency appreciates, becomes stronger. Real exchange rates

strengthen by 42% (the Czech Republic), 26% (Brazil), even 50% (Israel until lately, despite

the fact that the exchange rate system there is hardly fixed). This has a disastrous effect on

the trade deficit: it balloons and consumes 4-10% of the GDP.

This phenomenon does not happen in non-fixed systems. Especially benign are the crawling

peg and the crawling band systems which keep a pace with inflation and do not let the

currency appreciate against the currencies of major trading partners. Even then, the

important question is the composition of the pegging basket. If the exchange rate is linked to

one major currency - the local currency will appreciate and depreciate together with that

major currency. In a way the inflation of the major currency is thus imported through the

foreign exchange mechanism. This is what happened in Thailand when the dollar got

stronger in the world markets.

In other words, the design of the pegging and exchange rate system is the crucial element.

In a crawling band system - the wider the band, the less the volatility of the exchange rate.

This European Monetary System (EMS - ERM), known as "The Snake", had to realign itself

a few times during the 1990s and each time the solution was to widen the bands within

which the exchange rates were allowed to fluctuate. Israel had to do it twice. On June 18 th,

the band was doubled and the Shekel can go up and down by 10% in each direction.

But fixed exchange rates offer other problems. The strengthening real exchange rate attracts

foreign capital. This is not the kind of foreign capital that countries are looking for. It is not

Foreign Direct Investment (FDI). It is speculative, hot money in pursuit of ever higher

returns. It aims to benefit from the stability of the exchange rate - and from the high interest

rates paid on deposits in local currency.

Let, us study an example: if a foreign investor were to convert 100,000 DEM to Israeli

Shekels last year and invest them in a liquid deposit with an Israeli bank - he will have

ended up earning an interest rate of 12% annually. The exchange rate did not change

appreciably - so he would have needed the same amount of Shekels to buy his DEM back.

On his Shekel deposit he would have earned between 12-16%, all net, tax free profit.

No wonder that Israel's foreign exchange reserves doubled themselves in the preceding 18

months. This phenomenon happened all over the globe, from Mexico to Thailand.This kind

of foreign capital expands the money supply (it is converted to local currency) and when it

suddenly evaporates - prices and wages collapse. Thus it tends to exacerbate the natural

inflationary-deflationary cycles in emerging economies. Measures like control on capital

inflows, taxing them are useless in a global economy with global capital markets.

The other option is "sterilization": selling government bonds and thus absorbing the

monetary overflow or maintaining high interest rates to prevent a capital drain. Both

measures have adverse economic effects, tend to corrupt and destroy the banking and

financial infrastructure and are expensive while bringing only temporary relief.

Where floating rate systems are applied, wages and prices can move freely. The market

mechanisms are trusted to adjust the exchange rates. In fixed rate systems, taxes move

freely. The state, having voluntarily given up one of the tools used in fine tuning the

economy (the exchange rate) - must resort to fiscal rigor, tightening fiscal policy (collect

more taxes) to absorb liquidity and rein in demand when foreign capital comes flowing in.

In the absence of fiscal discipline, a fixed exchange rate will explode in the face of the

decision makers either in the form of forced devaluation or in the form of massive capital

outflows.

After all, what is wrong with volatile exchange rates? Why must they be fixed, save for

psychological reasons? The West has never prospered as it does nowadays, in the era of

floating rates. Trade, investment - all the areas of economic activity which were supposed to

be influenced by exchange rate volatility - are experiencing a continuous big bang. That

daily small fluctuations (even in a devaluation trend) are better than a big one time

devaluation in restoring investor and business confidence is an axiom. That there is no such

thing as a pure floating rate system (Central Banks always intervene to limit what they

regard as excessive fluctuations) - is also agreed on all economists.

That exchange rate management is no substitute for sound macro- and micro-economic

practices and policies - is the most important lesson. After all, a currency is the reflection of

the country in which it is legal tender. It stores all the data about that country and their

appraisal. A currency is a unique package of past and future with serious implications on the

present.

2.10 Devaluation of currency from the prospective of China's:

China's devaluation of the Yuan, on 11 Aug surprised global markets and left analysts

wondering what it might mean. Leaders in Beijing are probably asking themselves the same

thing.

China's monetary authorities cut the currency's value against the dollar by 1.9 percent, the

biggest move in years. Was this a liberalization of the country's system for managing the

Yuan, a step to stimulate China's flagging economy, or the beginning of a currency war?

Mostly, it was a combination of the first two -- but the question now is how authorities will

strike this balance between pro-market reform and pro-export stimulus.

2.10.1 The People's Currency

The central bank sets a rate for the Yuan each day, and the currency is then allowed to vary

plus or minus 2 percent from that figure. Market pressure, thanks to capital outflows and

China's slowing exports, has lately been pushing the currency lower in its permitted range.

In cutting the "daily fix" by almost 2 percent, the central bank has accommodated the

market's preference for a cheaper Yuan -- and, in effect, that's how the People's Bank of

China explained its action.

Moreover, it added vaguely, from now on the daily fix would take the previous day's closing

rate into account, suggesting a new and more market-oriented approach. That's something

outsiders, including the International Monetary Fund, have wanted to see. The IMF is in

discussions with Beijing about including the Yuan as part of its official international

currency. Beijing wants the Yuan to be part of the system as an affirmation of China's

standing in global economic governance.

At the same time, though, this devaluation is a form of economic stimulus that promotes

Chinese exports and makes imports from abroad more expensive -- making this

a suspiciously convenient moment for China's leaders to recognize the merit of market

forces. Later, when those forces point in the opposite direction -- pulling the Yuan up not

down, and threatening to put Chinese exporters at a disadvantage -- Beijing will face a

dilemma. That will be a revealing moment. Outsiders can't be sure what will happen, and

China's leaders probably don't know either.

For now, China's trading partners, also growing sluggishly, have to contend with a

devaluation that's less convenient for them than for Beijing. As things stand, they have no

great cause for concern. The devaluation is big by Chinese standards, but hardly dramatic by

the standards of countries with floating exchange rates.

U.S. policy-makers, especially sensitive to Chinese manipulation of its currency, should also

bear in mind that, in trade-weighted terms, theYuan has been strengthening lately. The rising

dollar has pulled it higher against the yen, euro and other currencies. Tempting as it may be

for campaigning politicians to deplore the opening of fresh economic hostilities, this is a

long way short of currency war.

2.11. Why China's currency has two names?

Some refer to the currency as the Yuan, others call it the Renminbi. Both names are

perfectly good, but in slightly different ways.

"Renminbi" is the official name of the currency introduced by the Communist People's

Republic of China at the time of its foundation in 1949. It means "the people's currency".

"Yuan" is the name of a unit of the renminbi currency. Something may cost one Yuan or 10

Yuan. It would not be correct to say that it cost 10 renminbi.

2.11.1 Silver dollars

The word "Yuan" goes back further than "renminbi". It is the Chinese word for dollar - the

silver coin, mostly minted in the Spanish empire, used by foreign merchants in China for

some four centuries.This is the "piece of eight" (or "real de a ocho") beloved of pirates and

their parrots - worth eight reales and known as a peso in Spanish and a dollar in English.

The European merchants who started arriving in the early 16th Century went to China to buy

silk and porcelain. Their Chinese partners wanted silver, preferably these large European-

style silver coins.China, as a result, was the destination of much of the silver coming from

the mines of Spanish-America.

The dollar of choice among Chinese businessmen was for a long time the Spanish Colonial

Mexican dollar. Later it was the so-called Eagle Dollar produced by independent Mexico. In

the second half of the 19th Century major trading nations starting producing their own "trade

dollars".The UK produced a trade dollar, and so did the US, as discerning Chinese traders

demanded higher-quality silver than the metal used in regular US dollars.

“I sometimes think that the whole renminbi/Yuan issue is a sinister plot by the Chinese

designed specifically to deter people from discussing Chinese currency policy” Paul

Krugman, Nobel-winning economist

China's first domestically produced machine-struck dollar coin, or Yuan, was minted in

Guangdong province in 1890. The Chinese phrase for the US dollar is "mei Yuan", the

American Yuan. The Japanese and Korean names for their currencies, the yen and the won

respectively, are derived from the same Chinese Yuan character. The Chinese name for the

Japanese yen is the "ri Yuan".

In the world's high-flying financial circles, the word "renminbi" (or RMB) is often preferred

to "Yuan" (or CNY, short for "Chinese Yuan").

Nobel-prize-winning economist Paul Krugman, writing in the New York Times in October,

noted that no-one seemed to mind if you talked about the pound's value, but talking about

the Yuan's value would sometimes draw disapproval. "I sometimes think that the whole

renminbi/Yuan issue is a sinister plot by the Chinese designed specifically to deter people

from discussing Chinese currency policy”.

2.11.2 Jiao and mao

The word they use is "kuai", which literally means "piece", and is the word used historically

for coins made of silver or copper.Also common is "10 kuai qian", literally "10 pieces of

money".

"Kuai" is colloquial, like "quid" in the UK and "buck" in the US, but it is the word used in

everyday Mandarin, whether you are in Beijing or Taiwan - which, of course, has its own

currency, the new Taiwanese dollar, also known as the Yuan.

The same thing happens again when you break down your Yuan into smaller units, the jiao

and the fen (one Yuan is equal to 10 jiao and one jiao is equal to 10 fen).

There is nothing wrong with the word jiao, it is just that most people use the word mao

instead.Anyone suspecting a link between the mao and Chinese former communist leader

Mao Zedong would be mistaken.The character is the same as Mao's surname, but the word

was used long before he came to prominence.

2.12. China's exchange rate policy:

China’s exchange rate is being controlled by government authorities: the People’s Bank of

China (PBoC: China’s central bank) manages the value of the renminbi. They do so by

fixing the USD/CNY-rate on each trading day. This is the exchange rate that applies to trade

flows into and out of China only.

2.12.1 Reasons for a stable exchange rate

A prime reason for China to keep the value of its currency low versus its trade partners, is

that it makes China’s exports cheaper, and thus more attractive. China believes such an

exchange rate policy is required to sustain a high growth rate. As a result of the managed

exchange rate that keeps renminbi relatively cheap, China’s growth depends to a large

degree on exports. Moreover, a stable exchange rate eliminates part of the exchange rate

uncertainty for Chinese exporters and importers and their trading partners.

2.12.2 By-products of a fixed exchange rate

However, there are also several adverse effects that a fixed exchange rate creates.

Firstly, a necessary by-product of fixing the exchange rates is capital controls. China’s

financial markets are therefore relatively closed. For example, investments into China can

only be made under strict regulations and requirements.

Secondly, a fixed exchange rate is only attainable if the PBoC stands ready to exchange

renminbi for US dollars and vice versa at the announced USD/CNY-rate. If a Chinese

exporter receives US dollars for its exported products, US dollars are converted into

renminbi, which the Chinese exporter receives. As a result of this demand for renminbi and

the supply of US dollars, in theory the US dollar would have to depreciate in value versus

the renminbi. Subsequently, in order to offset the upward pressure this gives on the

renminbi, China’s central bank sells renminbi in exchange for US dollars or US dollar-

denominated assets (most notably US Treasuries). Thereby, the PBoC accumulates foreign

reserves. Unfortunately, these reserves typically have relatively low yields, especially

compared to the yields earned on Chinese investments. This is a not-so-welcome by-product

of controlling the exchange rate.

Moreover, if fixing the exchange rate requires selling renminbi to counter any upward

pressure on the currency, it increases the amount of renminbi in the domestic economy: a

build-up of the domestic money supply. As more currency is available, inflationary

pressures arise. This is very undesirable, given that in the past high inflation has often lead

to social unrest.

2.12.3 Effects from sterilized intervention

The PBoC can avoid these inflationary pressures if its currency intervention is sterilized.

Sterilized intervention means that the extra renminbi created are mopped up by the central

bank through selling central bank and/or government bonds for which is receives renminbi

in return. Hence, when the PBoC uses sterilized intervention, it reverses the expansion of the

domestic supply of renminbi by issuing central bank bonds and receiving renminbi in

exchange. However, if the central bank issues these bonds, it has to make the required

interest payments to the bond holders. This is another cost of sterilized intervention.

Lastly, there are risks associated to the value of the described foreign reserves build-up. As

the foreign exchange reserves of China are close to, or have already passed, 50% of China’s

GDP, and given that most of the reserves are denominated in US dollar, a drop in the value

of the dollar or dollar assets imply enormous costs for the Chinese.

2.12.4 Past exchange rate policy

China decided starting from the Asian crisis in 1998-1999 to keep its currency fixed versus

the value of the US dollar. It did so until July 2005. It then switched to a managed float of

USD/CNY, where the value of the renminbi gradually increased versus the US dollar (thus,

USD/CNY gradually declined). In the course of three years, the renminbi strengthened by as

much as 21% versus the US dollar. A change in China’s exchange rate policy came about in

August 2008, as China’s export sector came under enormous pressure after the US subprime

crisis eventually led to a wide decline in world trade. To protect Chinese exporters from

further competitive pressures, China again decided to ‘re-peg’ its currency vis-à-vis the US

dollar. Only in June 2010, the PBoC announced that the exchange rate would be made more

flexible again, after which USD/CNY gradually appreciated at a 5% annual pace.

2.13 Devaluation of Yuan for the first time in two decades, and why it matters?

It decided to devalue the Yuan for the first time since 1994, shaving close to 2pc off its

value on August 11.

The Yuan - also known as the Renminbi - is pegged against the US dollar by Beijing

authorities, an arrangement they recently decided to shake up.

2.13.1 Who decides what the Yuan is worth?

The People’s Bank of China (PBoC) implemented a new methodology for fixing the

currency on August 11, affecting how the the "reference rate" is set.

That reference rate - or fixing rate - is the official exchange rate at which the PBoC wants

the US dollar to trade against the Yuan. The Yuan is allowed to trade within a 2pc range

either side of that reference rate, which is announced to the market at 9.15am in Shanghai

every day.

This contrasts with a free-floating currency, like the pound or the euro. The value of those

currencies is determined entirely by supply and demand, and how traders expect those things

to vary in future.

The PBoC refers to the Yuan regime as a “managed floating exchange rate regime”, but the

word “managed” does a lot of the work in that description. Economists believe that if the

Yuan was set free, it could plunge by as much as 10pc against the dollar, or perhaps by as

much as 30pc.

2.13.2 How is the Yuan's value controlled?

The PBoC ensures that the Yuan trades within its range by buying or selling dollars in order

to steer the Yuan's value.

If the PBoC creates more Yuan and buys dollars, the Yuan's value will fall. It’s not a

difficult job for a central bank to depreciate its own currency: just create more and the

currency will be worth less.There are no limits on how much currency a central bank can

create, although the distortions that arise during the process create may at some point

outweigh the benefits.

Conversely, if the PBoC uses its dollar reserves to buy Yuan, then the Yuan's value will rise.

This is slightly trickier; foreign currency reserves are finite. But China’s reserves are

massive, and no-one fears that they’re about to run out.As the Yuan is currently seen as

overvalued, it’s this latter kind of intervention we've seen more recently, ensuring that the

currency has appreciated.

2.13.3 What’s changed about how the Yuan is valued?

The process for setting the "reference rate" is now more reflective of "foreign exchange

demand and supply", the PBoC said as it introduced its new system.

It's the first time the central bank has changed how the Yuan is valued in about a decade.

The production of the new reference rate is now based more closely on where the Yuan

stopped trading the previous day, the “close” price of the currency - where it traded within

the 2pc band around the reference rate.

As the new fixing methodology was implemented, the Yuan slid by 1.9pc against the dollar,

its biggest one-day fall since 1994, bringing it into line with the previous day’s close.

Capital Economics has argued that the adjustment to the Yuan's value is a result of this

mechanical change, and not a push to boost the economy, or to win favour with the

International Monetary Fund.

2.13.4 What will happen next?

The market still thinks the Yuan is overvalued, and with a new fixing regime in play, they’re

liable to keep testing it for some time. But the PBoC has now made clear that it’s willing to

fight back to stabilise the currency as it sees fit.

Kit Juckes, of Societe Generale, said: "The PBoC has managed to kill off the notion that the

new currency regime in China will allow the renminbi to weaken by 2pc on a daily

basis."The central bank has dismissed claims that it is attempting to engineer 10pc

depreciation against the dollar as "groundless".Yi Gang, deputy governor of the central

bank, said it stood ready to step in if volatility became "excessive" and the market started

"behaving like a herd of sheep". "Trust the market, respect the market, fear the market, and

follow the market," he told a press conference.

Amy Yuan Zhang, of Nordea, said that the PBoC's next policy move - whenever that comes

- might be to widen the band in which the Yuan is allowed to trade.

2.14 Why China Currency Crises Matter?

2.14.1. It could be serious

China’s devaluation may be best seen as a distress signal from Beijing policymakers – in

which case the world’s second-largest economy may be far weaker than the 7% a year

growth that official figures suggests. China has been trying to engineer a shift from export-

led growth to an expansion based on consumer spending – while simultaneously trying to

deflate a property bubble. Last week’s move, which loosened the Yuan’s link to the value of

the dollar, suggested some policymakers may be losing patience with that strategy, and

reaching for the familiar prop of a cheap currency. Nobel prize-winning economist Paul

Krugman described the decision as “the first bite of the cherry,”suggesting more could

follow, and in a reference to Chinese president Xi Jinping, warned that such a modest move

gave the impression that, “when it comes to economic policy Xi-who-must-be-obeyed has

no idea what he’s doing”.

If its economy really is much weaker than Beijing has let on, it would be alarming for any

company hoping to export to China — something firms in Britain have been encouraged to

do in recent years, to lessen reliance on the stodgy European economies. China was the

sixth-largest destination for British exports last year. China will remain a vast market; but it

may not be quite such a one-way bet as some analysts have suggested. And when it comes to

the challenges facing Chinese policymakers, Russell Jones, of consultancy Llewellyn

Consulting says: “The potential for getting this wrong is quite high.”

2.14.2 A less costly Christmas

China has been trying to shift from being a vast factory producing cut-price consumer goods

for the rest of the world. Yet glance at the label on almost any T-shirt or toy – let alone

consumer gadget – and it’s still likely to read “Made in China”. A country’s currency is not

the only determinant of how much its goods will cost when they reach the high street:

Chinese wages have been rising, making its products less competitive, and the price of raw

materials and shipping is also important. However, the devalued Yuan will force China’s

Asian rivals, such as Indonesia and South Korea, to compete even harder in response; and

the result may be a few pence off the price of Chinese-made Christmas presents. Martin

Beck, of consultancy Oxford Economics, says, “Almost 9% of the UK’s goods imports

come from China, a share that has doubled over the last decade.” So there will be a direct

disinflationary effect from cheaper imports. Lower Chinese economic growth could depress

oil prices, and thus lower costs for motorists.

2.14.3 Cheaper petrol at the pump

China’s apparently insatiable demand for natural resources has been a key factors supporting

the price of oil in recent years. So fears that China’s economy is in trouble tend to

undermine oil prices – and that probably means cheaper petrol in Britain. Of course, there

are other factors, including strong oil production in the US; but global oil prices resumed

their decline last week following China’s move, dipping back below $50 a barrel. In coming

months, weak Chinese demand could force down the cost of many commodities, from oil to

iron ore.

2.14.4 Delayed rate rises

Central bankers in the US and the UK have been issuing warnings for months that, with

growth strengthening, they are preparing to start pushing up interest rates – reversing the

emergency cuts made in the global credit crunch. Mark Carney, the Bank of England

governor, has suggested“the turn of the year” might be the moment to consider tightening

monetary policy (ie raising rates); Janet Yellen at the US Federal Reserve has signalled that

an increase could come as early as September. However, if the cheaper Yuan cuts the price

of imports, this will undermine inflation, which is already at zero in the UK; and could delay

a rate rise. A renewed bout of market turbulence as global investors assess the implications

of China’s decision could have the same effect.

2.14.5 Deflation, deflation, deflation

In the short term, lower-than-expected borrowing costs will benefit indebted consumers in

the west – including Britain’s mortgage-holders. But some analysts believe China’s decision

is the latest evidence of a deep-seated lack of demand in the global economy, which will

unleash deflation. Brief periods of falling prices – particularly if concentrated among one or

two commodities – can be good news; but economists fret about periods of persistently

falling prices, which can undermine spending and investment and feed through to wages, as

consumers and businesses delay spending, expecting goods to be even cheaper in future.

And if a fresh downturn does come, central bankers have little ammunition left to tackle it,

since interest rates in the US, the UK and Europe are already on the floor. Economist Ann

Pettifor, of thinktank Prime, who foreshadowed the credit crunch in her 2006 book, The

Coming First World Debt Crisis, believes the developed economies face some of the

challenges felt by Japan during its “lost decade”, when it suffered both deflation and weak

demand – but unlike Japan, many developed economies, not least the UK, would enter any

new crisis under a heavy burden of borrowing. “It’s the pressure of debt on consumers,

corporates, municipalities,” Pettifor says, raising the spectre of the kind of debt trap

identified by the US economist Irving Fisher in the wake of the Great Depression. Not

everyone is so pessimistic, and Carney has shrugged off the idea that deflation is a threat in

the UK; but as Neil Mellor, of BNY Mellon, put it in a research note on Friday, “as we

watch and wait, the market will be anxiously aware that a sustained depreciation could have

ramifications across the globe by shifting the inflation dynamic at a most inopportune time.”

Australia’s economic buoyancy has depended to some extent on its sales of natural

resources to Asian neighbours such as China.

2.14.6. Tough times for Oz

Australia has experienced an impressive economic boom in recent years on the back of

selling natural resources, including coal and iron ore, to its Asian neighbours, and China

accounts for more than a quarter of its exports. So weakness in the Chinese economy is bad

news for Australia. Research by consultancy Oxford Economics last week, which modelled

the impact of a 10% Chinese devaluation, accompanied by a sharp slowdown, suggested

other hard-hit countries could include Brazil, Russia, Chile and Korea.

2.14.7. Even more pain for Greece

If the Chinese devaluation does bring what one City analyst, Albert Edwards, last week

called a “tidal wave of deflation” to the global economy, the most vulnerable countries will

be those that are heavily in debt – because while wages and profits fall in a deflationary

period, the value of debts remains fixed, making them harder to service (to pay interest on).

And economies where consumer demand and confidence is already weak tend to be hit

harder by the reduced spending that deflation can bring. As economists at consultancy

Fathom said last week, “peripheral European economies”, not least crisis-hit Greece, fit that

definition. Greece is already suffering deflation after repeated cuts in wages and benefits as

the government tries to balance the books, and if it worsens, that will only make its

gargantuan debts – worth more than 170% of the size of the economy – harder to service.

2.14.8. Currency wars

Beijing’s move was ostensibly offered as part of measures to open up its financial system,

and allow foreign exchange markets more say over the value of the Yuan – something

America has long demanded as evidence that China is genuinely open to financial reform.

The International Monetary Fund described the move as welcome. But the devaluation was

nevertheless greeted angrily in Washington. New York senator Chuck Schumer said: “For

years, China has rigged the rules and played games with its currency, leaving American

workers out to dry. Rather than changing their ways, the Chinese government seems to be

doubling down.” Republican senator and former US trade representative Rob Portman

accused China of trying to gain an unfair trade advantage over America though “currency

manipulation” – just as the US is negotiating an important trade agreement, the Trans-

Pacific Partnership, with a number of China’s rivals, including Japan.

If Beijing allows the Yuan to decline further in coming months, it could increase trade

tensions, or even a “currency war”, in which the world’s big trading blocs face off in a

beggar-thy-neighbour battle to seize the largest possible share of global consumer demand.

For now, a 4% devaluation in the Yuan is more of a hairline crack in the world economic

order than a seismic shift; but policymakers will be weighing up its consequences long after

they return from their summer break.

2.15 What China's Yuan move means for emerging markets?

In the very short term, the dust may be settling on the depreciation of the Chinese currency,

the Yuan. Over the next six to 12 months, however, concerns remain, including for

developing nations that export to China or compete with China in export markets.

Compared with the period since China became a dominant global economic power, the

recent daily moves in the Yuan-dollar exchange rate have been extraordinary. The Chinese

authorities most likely welcome an adjustment of the currency as the Yuan has risen in real

terms by 18 percent against the dollar in the last two years and growth has slowed. In

addition, a weaker Yuan provides an alternative to monetary and fiscal policy, thus adding

to policy flexibility. China is also aiming to let the Yuan depreciate and appreciate more

flexibly in line with market forces to aid inclusion in the International Monetary Fund's

special drawing rights currency basket, a key asset in terms of international reserves debts.

What the depreciation says about China's growth concerns should be a worry for emerging

markets that export heavily to China, particularly commodity producers such

as Brazil, Russia, South Africa, Indonesia, and Malaysia. A weaker Yuan is also a concern

for developing nations that compete with China in exporting similar goods and services to

similar destinations. Taiwan and South Korea face some of the greatest risks,

but Thailand and the Philippines may also be affected and even Mexico may feel the effects.

The situation is probably manageable under our base-case scenario, which is that the Yuan

gradually weakens further to 6.60 to the U.S. dollar in 12 months' time. However, the

relevant countries will face a greater impact in the risk case, whereby the Yuan depreciates

more sharply, perhaps as a result of even weaker Chinese growth. In the risk case, these

nations' currencies may come under renewed pressure against the U.S. dollar. Emerging

market companies in countries whose currencies weaken against the U.S. dollar will also

find it harder to service U.S. dollar-denominated

If this Chinese risk case materializes, it would also come at a time when emerging markets

are suffering from a range of other issues. Since 2013, when the Federal Reserve started

scaling back its ultra-loose monetary policy, developing economies and markets have

suffered from the U.S. dollar strengthening and expectations of higher U.S. interest rates.

Political turmoil and the sharp drop in commodity prices have also weighed on Brazil and

Russia. Of the major nations, only India has emerged strongly.

Granted, a sharper-than-anticipated depreciation in the Yuan should act as a deflationary

force, especially if accompanied by further China growth jitters. This might lower the future

path of U.S. rates and restrain the rise of the U.S. dollar against emerging market currencies.

However, this type of depreciation would also most likely result from concerns about China

that would not be favorable for developing countries overall.

For investors in advanced economies, who typically have lower exposure to emerging

markets, this may not seem like a dominant investment concern. We have already addressed

worries over emerging markets within our portfolios by remaining underweight emerging

market equities compared with developed world stock markets, especially the euro zone and

Japan. But on a macro level, China is still the world's second largest economy, and the

developing world matters for global growth and hence for global markets. Wherever

investors are based, the Yuan and its effect on emerging markets are noteworthy issues to

watch.

2.16 Opportunities for Investors:

In the events of the last few months have presented investors an opportunity to enter or

increase their exposure to the China equity markets. Having interpreted the Chinese

government’s recent direct purchase of stocks as a big negative, most institutional investors

have forced down the prices of the major Chinese blue chips that trade in Hong Kong and

the U.S. In fact, since only a small number of mainland investors can purchase Chinese

companies traded in Hong Kong, most of the Hong Kong shares currently trade at prices

30% lower than the same company shares on the mainland.

What’s more, valuation levels of the MSCI China Index, which represents 26% of the MSCI

Emerging Markets Index, are near their decade lows. We believe that the distinct

undervaluation of the MSCI China Index relative to other world equities has increased the

likelihood of the emerging markets asset class beginning an extended period of relative

outperformance. If so, this represents an opportunity for investors to consider realigning

their asset allocation.

Besides benefiting from low valuations of the broader China markets, investors may also

add value to their portfolios in the long term by focusing on specific categories of stocks.

For instance, the recent devaluation should help Chinese exporters, effectively allowing

them to gain business by offering lower prices versus their competition. This is especially

true of companies that primarily export to the U.S. These companies have seen robust

growth in their U.S. revenues lately as the relative strength of the American economy has

boosted their sales volumes while the dollars they have received as revenues have expanded

in value relative to the Yuan. In short, their profit margins have grown wider as the Yuan

remains weak versus the dollar.

As China embraces a consumption-driven growth model, many American consumer goods

companies that have significant operations in China could see expanding sales in the future.

Although anecdotal evidence suggests that the Chinese consumer is becoming more

discerning and price-conscious, retail spending does not appear to have been affected

significantly by the stock market turbulence as only 6% of Chinese households own stocks.

In fact, China’s retail sales have been expanding at an annualized rate of 10% in recent

months.

On the whole, China’s current policies appear to have been designed to soften a mild growth

recession, something the country’s policy makers have handled successfully every 5-6 years.

Way back in 2008, at the peak of the global financial crisis, it was the Chinese government

that kept things going for the global economy through an enormous stimulus. China’s

voracious appetite for resources lifted commodity-producing economies from Brazil to

South Africa and it was Chinese demand that saved the day for American auto companies.

We believe that this time too Beijing’s proven capacity for a turnaround, along with the

attractive valuations of Chinese stocks, stands long-term investors in good stead.

CHAPTER – THREE

METHODOLOGY OF RESEARCH

3.1 Methodology:

This chapter deals with research methodology that aim at answering the research question

raised and accomplishing the research objectives set in the introduction. Research

methodology set out overall plan associated with the study. It provides a basic framework on

which the study is based. Before presenting the analysis and interpretation of data, it is

necessary that research methodology be described first, thus this report is prepared on the

basis of secondary data collected from various articles, news and internet also through

experts that they are professionally involved in investment and trade on foreign exchange

market.

3.2 Objective of Research:

To know about the overall activities of Chinese Government regarding the

devaluation of currency and its Economic policies.

Impact of devaluation of Yuan in Global Market.

China's exchange rate policy

3.3 Data Collection Method:

Review of economy polices implemented in Chinese market.

Depth study of Foreign exchange market

Review of Articles, blocs, internet

Opinion of expert through television, YouTube & other social Medias.

3.4 Limitation:

Research is based on Secondary Data.

Lack of Proper knowledge.

Research is based on assumption by the authors available in the internet.

Lack of accessibility with internet & Load Shedding problem.

CHAPTER- FOUR

ANANYSIS

4.1. Background:

China actually wanted its currency to steadily rise, for political reasons and to keep capital

from flowing out of China. The government devalued its currency is probably has more to

do with the dynamics of global currency markets than a sudden urge to help Chinese

exporters make their goods cheaper on the world market, it embarked on an objectives to

turn over its economy from one dependent on exports and outside influence to one that finds

more expansion through consumer spending and other internal factors. This directive has

come hand-in-hand with an effort to open up the country’s financial system to better secure

its place in the global economy and to use the outlet to help prevent systemic imbalances

that occur. The Chinese Yuan devaluation has been the major driver of the massive volatility

in the foreign exchange markets over the last two weeks. Asian currencies have been

negatively impacted the most due to the perceived risk of an impending currency war.

Economies could compete against each other to have the upper hand in elevating export

volumes and price value.

Falling commodity prices amid sluggish growth expectations in the Chinese economy have

had a spiraling effect on Latin American currencies as well. A devalued Yuan will have

negative consequences on China’s imports, many of which are sourced from major South

American countries. Crude prices have also been adversely impacted due to slow growth

coupled with higher cost of crude imports for the Chinese Economy. The below table relate

the currency gainer and loser in the global market

Fig 2.3 The figure above shows top gainer and losers of currency in the global market

The above figure explain that the Middle East countries are thus under pressure resulting

from the developments. The US dollar index has been affected unfavorably by the Yuan

devaluation, which goes against the ongoing talk towards hiking the US benchmark interest

rates. Developed countries thus have benefited in terms of their currencies with respect to

the US dollar, the exception being commodity currencies like the Australian dollar and the

Canadian dollar, which depreciated against the US dollar.

4.2 FX gainers and losers in the last two weeks:

The volatility for major currency pairs between the close of August 7 and August 21

has varied across economies depending on geography, domestic capabilities, and

trade dependence on China. Leading the top gainers was the Swedish krona with an increase

of 4.71% on a cumulative basis. The Swedish krona, which is an integral member of the

basket of currencies comprising the US dollar index, was helped further by positive

comments by the government regarding increased growth estimates.

The euro and the Swiss franc have been riding high, owing to the recent fall in the US dollar

index, which inherently constitutes the aforementioned currencies. On the other hand,

exhibiting a significant tumble, the Kazakhstani tenge fell by more than a quarter of its value

in view of the fact that the central bank moved towards a free-float regime from maintaining

a currency peg. The fall in crude prices among other commodities caused the downfall in the

Russian ruble, the Malaysian ringgit, and Latin American currencies.

4.3 Impact on the market:

Among global ETFs between the close of August 7 and August 21, the iShares MSCI World

ETF (URTH) fell by 6.60%. Also, the WisdomTree Bloomberg U.S. Dollar Bullish

Fund (USDU), which encompasses not only developed economies but also emerging market

currencies, dropped by 1.11%.

American depository receipts (or ADRs) trading across the globe between August 7

and August 21 ended on a negative note. BHP Billiton (BHP) plummeted by 10.24% during

the period, while oil major Exxon Mobil (XOM) fell by 6.11%. Sony (SNE) dropped by

8.64%.

http://marketrealist.com/quote-page/sne/

http://marketrealist.com/quote-page/xom/

http://marketrealist.com/quote-page/bhp/

http://marketrealist.com/quote-page/usdu/

http://marketrealist.com/quote-page/urth/

CHAPTER – FIVE

CONCLUSION AND RECOMMENDATION

China’s central bank has devalued the Yuan by nearly 2% against the US dollar for the

second time in two days to boost exports and take it a step nearer to becoming an official

reserve currency. Industrial production, investment and retail sales data were weaker than

expected, while at the weekend figures showed Chinese exports tumbled 8.3% in July, their

biggest drop in four months. After a string of weakening output growth figures going back

to last year, the authorities have come intense pressure internally to address the

slowdown with a dramatic policy shift.

People’s Bank of China set its daily “reference rate” for the Yuan at 6.2298 to $1, compared

with 6.1162 Yuan in effect 1.86% lower. That triggered a further fall in the currency

markets. As the authorities pick the mid-point from the previous day as the basis for the next

day’s reference rate, they were forced to devalue again or risk ignoring market forces.

Choosing the former, it set the rate at 6.3306, fractionally weaker than market close. The

spot rate has responded by falling another 1.6% on Tuesday, likely forcing a further

devaluation.

The currency moves are the biggest one-day falls in 20 years, and in particular, since China

reformed its currency system in 2005. Back then, it unpaged the Yuan, also known as the

Renminbi (RMB), from a strict tie with the dollar in favor of a looser tracking policy.The

successive devaluations follow a further shift in policy that means the bank will now expand

the criteria used to calculate the daily fix – the rate at which it determines the currency’s

value each morning and from which it is in theory allowed to move 2 percentage points in

either direction, although in practice the moves are much smaller.

Chinese businesses compete with regional rivals to supply the world with everything from

raw steel to fridges, and a cheaper Yuan will make Chinese exports less expensive,

potentially boosting the overseas sales that have been among the main drivers of growth

during the nation’s remarkable rise over the past three decades. However, controls on the

currency have given Chinese businesses a high degree of predictability when they plan

investments in industries heavily dependent on exports. The devaluation could prompt an

angry reaction from the US, which has consistently argued that the Yuan is undervalued,

damaging US exports. It could also force other Asian countries to devalue, making exports

to the US cheaper and increasing Washington’s trade deficit further.Central banks in the US

and the UK are toying with raising interest rates to combat the prospect of higher inflation.

But cheaper Chinese goods will reduce inflationary pressures and keep interest rates lower

for longer. Less welcome will be the export of unemployment, as Beijing effectively prices

western workers out of a job to protect its own economy.



make their goods cheaper on the world market.China wanted a steady rise against the trade

to keep the appreciation in gradual and all about today is managing the pace of trade

weighted by helping exporters with a cheaper currency hereby maintaining a strong currency

to prevent capital outflow. The US policies makers especially sensitive to Chinese

manipulation of its currency, should also bear in mind the weighted terms the Yuan has been

strengthening lately. The rising dollar has pull higher against the Yen, Euro and other

countries.

The Chinese Government believes that exchange rate policies is required to sustain a high

growth rate and is being controlled by the people bank of China. China devaluation may be

the best seen distress signal from Beijing policies makers in which case the world second

economy may be far weaker then the 7% of a year growth.

Country currency is not only determinant of how much of its goods cost and reach the high

street, hence China has been vast factory producing cut price consumers goods for the rest of

the world yet glance at the lebel on almost on T- shirt , toys and other consumers gadgets

and is still likely to need made in China. The People of China wages have been rising

making its product more competitive and the price of raw materials and shipping products

however the devalued Yuan will force china's Asian Rivals such as Indonesia South Korea

to compete.

Compared with the period since China became a dominant global economic power, the

recent daily moves in the Yuan-dollar exchange rate have been extraordinary. The Chinese

authorities most likely welcome an adjustment of the currency as the Yuan has risen in real

terms by 18 percent against the dollar in the last two years and growth has slowed. In

addition, a weaker Yuan provides an alternative to monetary and fiscal policy, thus adding

to policy flexibility. China is also aiming to let the Yuan depreciate and appreciate more

flexibly in line with market forces to aid inclusion in the International Monetary Fund's

special drawing rights currency basket, a key asset in terms of international reserves debts.

What the depreciation says about China's growth concerns should be a worry for emerging

markets that export heavily to China, particularly commodity producers such

as Brazil, Russia, South Africa, Indonesia, and Malaysia. A weaker Yuan is also a concern

for developing nations that compete with China in exporting similar goods and services to

similar destinations. Taiwan and South Korea face some of the greatest risks,

but Thailand and the Philippines may also be affected and even Mexico may feel the effects.

The situation is probably manageable under our base-case scenario, which is that the Yuan

gradually weakens further to 6.60 to the U.S. dollar in 12 months' time. However, the

relevant countries will face a greater impact in the risk case, whereby the Yuan depreciates

more sharply, perhaps as a result of even weaker Chinese growth. In the risk case, these

nations' currencies may come under renewed pressure against the U.S. dollar. Emerging

market companies in countries whose currencies weaken against the U.S. dollar will also

find it harder to service U.S. dollar-denominated

If this Chinese risk case materializes, it would also come at a time when emerging markets

are suffering from a range of other issues. Granted, Yuan should act as a deflationary force,

especially if accompanied by further China growth jitters. This might lower the future path

of U.S. rates and restrain the rise of the U.S. dollar against emerging market currencies.

However, this type of depreciation would also most likely result from concerns about China

that would not be favorable for developing countries overall.

A project report on devaluation of chinese currency yuan

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