Impact of devaluation of Chinese Currency on Indian Financial System

The devaluation of the Chinese currency has created riles across global financial markets. China

is the world's largest exporter and its exports formed 13.7% of the global exports and close to

one-and-a-half time’s United States' exports last year.

On the other hand, India's exports are a mere 1.9% of total world exports and close to 14% of

China's exports. Trade linkage to growth in China is high and hence it is facing the heat of falling

global demand, India Ratings and Research (Ind-Ra) said in a report. China cut the value of its

Yuan currency against the US dollar for the second day in a row Wednesday, taking the

reductions to 3.5 per cent this week — the largest in more than two decades. The move has

reinforced concerns about the world's second largest economy, and analysts are divided over the

reasons behind the move and the consequences it will have. Chinese authorizes have allowed

Yuan or Renminbi, their currency, to move in a band of 1.9%.

Why is China doing this now?

The People's Bank of China (PBoC) said Tuesday's "one-time correction" in the Yuan is part of a

larger scheme to give the market a bigger say in the value of the currency, also known as the

renminbi (RMB).At the same time Chinese growth has been slowing, and a devaluation can

boost the economy by making exports -- a key sector -- cheaper for overseas buyers.

Where does the Yuan stand internationally?

A decades-long boom has turned China into the world's second-largest economy, but despite

being the world's largest trader in goods its role in the global financial system remains relatively

limited. It has been looking to build up its presence, setting up a new multilateral Asian

Infrastructure Investment Bank, and is also pushing to join the exclusive club of the International

Monetary Fund's basket of "special drawing rights" (SDR) reserve currencies. But it must show

progress on liberalizing the Yuan regime to win membership.

How does China's foreign exchange mechanism work?

The Yuan is generally far more stable than most major currencies. The China Foreign Exchange

Trade System -- which operates the national foreign exchange market -- and the central bank

carry out a poll of market makers to set a daily reference rate, also known as the central parity

rate. The Yuan is allowed to move up or down two per cent from it each day.

What are the effects?

The jury is still out. For China, the move could deliver both an export and economic boost -- but

will also make imports more expensive, potentially pushing up inflation, and raise costs for

Chinese firms with dollar-denominated debt. For the rest of the world, some analysts believe the

move could trigger currency wars, as other emerging market countries devalue to compete.

Market and economic turmoil could cause the United States to delay plans to raise interest rates

as the world's biggest economy recovers.

Is this a devaluation?

Yes and no. China did not use the term devaluation to describe Tuesday's drop, which it called a

"one-time correction", and said Wednesday's fall was also a reflection of the new system. But the

market widely viewed the move as devaluation. Here are a few implications following

devaluation of the Chinese currency.

1. The devaluation of the Yuan, intended to boost Chinese exports, has made investment in

China cheaper. This is leading foreign investments away from India.

2. The move has strengthened the dollar value, which has negatively impacted major world

currencies including the Indian rupee.

3. India's exports will be hit and the trade deficit might widen after the devaluation of Yuan,

which is bound to raise the competitiveness of outbound shipments from the neighboring

country.

4. The dramatic move surprised markets and led to a wave of selling on US and European equity

bourses, as well as across many commodity exchanges.

5. The value drop of Yuan against the US dollar will put pressure on the US because it wants the

Yuan to appreciate, which would help with its trade.

6. Analysts are also calculating the devaluation`s impact on the timing of the US Federal Reserve

plan to raise its near-zero federal funds rate this year. This is fueling further speculations that Fed

might not raise rates.

How The Renminbi Devaluation Will Impact India

1) The Indian rupee slipped to a two-month low of 64.26 against the US dollar on Tuesday

tracking the devaluation of the renminbi. Other currencies such as the Australian dollar and the

South Korean won also lost ground.

2) The over 0.5 per cent fall in the rupee weighed on traders' sentiments, resulting in a drop in

equity markets. Both the BSE Sensex and the Nifty traded with 0.4 per cent losses.

3) According to SV Prasad of Chime Consulting, renminbi's devaluation may push the Reserve

Bank of India to cut interest rates in India. Lower interest rates will put off foreign investors and

will further weaken the rupee, he added.

4) However, fund manager Sandip Sabharwal said India should not be too worried about the

devaluation in renminbi. "Analysts are out with predictions of how a 1.5 per cent fall of Chinese

currency will lead to a sharp increase in dumping etc. However the Indian rupee has also fallen

nearly 0.8 per cent in sympathy and is now down 5 per cent over the last one year. It is hard to

see a major impact of this on Indian stock markets or the economy unless Yuan depreciation

becomes a trend which seems unlikely at this stage," he said.

5) A fall in the value of the rupee is good for Indian exporters and sectors such as IT and pharma

are seen gaining from the depreciation in the rupee. IT stocks were the top performers in stock

markets today. However, China-focused Indian companies saw selling pressure because the

devaluation of renminbi will make imports costlier in the country. As a result metal stocks saw

selling pressure and underperformed broader markets.  

Impact on India’s Trade

India and China officially resumed trade in 1978. In 1984, the two sides signed the Most

Favoured Nation Agreement. India-China bilateral trade, which was as low as $2.9 billion in

2000-01, reached $72.3 billion in 2014-15 (exports: $11.9 billion and imports: $60.4 billion),

making China India’s largest goods trading partner. India has a whopping trade deficit with

China close to $50bn in 2014-15 on account of rising imports coupled with weak export

dynamics.  

The devaluation of the Yuan will not have a significant impact on Chinese exports, as the

currency is still highly overvalued. In addition, the Indian rupee also lost some value against the

US dollar following the decline in Yuan, thereby supporting a modest short-term impact on

India. However, if this adjustment of the currency continues then as per the J-curve effect;

Chinese exports will only increase as they become more competitive. This, in turn, will have a

negative impact on Indian exports. Further, there will be an influx of Chinese goods into India,

which will result in widening the already rising trade deficit with China. India’s major export

items to China consist of primary commodities with cotton, copper and mineral fuels alone

constituting more than 45 per cent of the total exports. Meanwhile, India’s major imports from

China are electrical machinery and nuclear appliances (45 per cent of total imports).  

A reduction in the cost of Chinese goods can also exacerbate the problem of dumping into India

from China. Tyre makers, steel industry and organic chemicals, petrochemicals industry are

already reeling under the increasing dumping cases from China as lower currency incentivizes

the country’s exports.

In the joint statement between India and China during Prime Minister Narendra Modi’s visit to

China in May 2015, it was agreed that both sides will take necessary measures to remove

impediments to bilateral trade and optimally exploit the present and potential complementarities

in identified sectors, including Indian pharmaceuticals, Indian IT services, tourism, textiles and

agro-products. The two sides resolved to take joint measures to alleviate the skewed bilateral

trade so as to realize its sustainability.

The impact of this devaluation will depend on the horizon one takes. The short term impact can

be negative in some sectors like tyres, pharmaceuticals, textile and capital goods due to a sudden

change in terms of trade and fear of dumping. However, in the long run there will not be material

impact particularly in services till such time China dismantles the state monopoly over services.

However, India has all options at its disposal under the WTO frame-work to tide over the short

run impact.

If the Yuan continues to lose value, then it might create pressure for the Reserve Bank of India

governor to intervene to provide relief for the exporters and cut the key interest rate else the

Indian goods would become less competitive.