China Currency Devaluation & Its Impact

The Chinese government has allowed its official currency, Yuan, to decline by about 4% against the US dollar. The 3pc devaluation over August 11-12 was the largest single move since 1994.

Reasons for Devaluation

• 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.
• China is seeking to build on its 2005 reforms in an effort to have the yuan included in the International Monetary Fund (IMF) basket of special drawing rights (SDR) reserve currencies. Its remaining controls have been a stumbling block in gaining admittance to the select group of the US dollar, the euro, the pound and the yen. The bank’s move to include more information when setting its daily fix can be seen as a relaxation of controls, moving the currency a step closer to satisfying the IMF’s entry requirements.

Estimated Impacts of Devaluation

• Adverse impact on the textile exports from India: The Indian textile industry is already coping up with lower demands in the global markets. And now with Yuan’s devaluation, things are expected to get worse before they turn better.
• It has exposed the vulnerability of a number of the Asian economies that had built up massive stocks of foreign currency debt or had seen their domestic bonds being lapped up by investors in the Western world stuck with extremely low interest rates.
• The depreciation of the Chinese currency effectively ‘exports’ its deflation to other regions – particularly the US and Europe – by making Chinese imports cheaper. Thus it not only creates problems for local producers in these regions, it also makes the task of pushing inflation up harder, which could prolong the global recession.
• The biggest problem China’s new currency regime creates, is that it compounds the levels of uncertainty in the global financial markets. To start with, there is the uncertainty about when and by how much China will engineer its next round of depreciation. The new system of a managed float enables it to let the currency slip whenever it finds it imperative strategically.
• Besides, there is an increased ‘risk’ that the US Federal Reserve might take into account the impact of the emerging market mayhem and push back its rate lift-off from December.
• Some analysts fear that, with oil prices falling, the Gulf economies will revalue their currency peg against the dollar so that each dollar of oil revenues translates into higher local currency revenue.