Devaluation of the yuan by the People’s Bank of China last week has rattled the global markets. In response to this, currencies across the globe fell and Indian rupee depreciated from 63.76 on August 10 to 64.92 on August 13. With this action, China has tried to kill two birds with one stone. The first one related to falling exports slowing GDP growth. China’s GDP growth has high linkages to external trade. As the world’s largest exporter Chinese exports constitute 13.7 per cent of the global exports.
However, China has been battling with falling exports as the globally exports have been sliding. Global exports contracted in nine out of the 10 months until May 2015, and fell six per cent on average during this period. China’s exports witnessed a contraction of 8.3 per cent in July 2015. This decline in global exports has put high pressure on the export-driven Chinese economy.
By devaluing the yuan, China expects to regain some export competitiveness which had got eroded due to pegging of yuan to US dollar. Between 2011 and 2015, while yuan had risen 4.46 per cent against US dollar, other currencies such as Indian rupee, Thai bath and Malaysian ringgit had fallen by 30.4 per cent, 15.03 per cent and 22.9 per cent respectively.
Although it is still not clear whether other countries will follow China and get into a competitive devaluation of their currencies, the event itself has resulted in devaluation of the currencies of several countries. And so far as their exports do not get hurt unduly by this Chinese action and their currencies find lower levels vis-a-vis US dollar to wipe out the gains of the yuan, an open currency war looks unlikely.
However, cheaper Chinese products will exert pressure on developed economies, which are already facing deflationary risks. It will also put the US Fed in a dilemma as it considers raising interest rates. Any increase in rate could make the dollar further stronger, affecting its exports.
Moreover, a number of economies including India, stand to gain due to cheaper global commodity prices. Even the US stand to gain as most of the global commodity prices are US dollar denominated. A devaluation of the yuan has sent a clear signal to the global market about the weakness of Chinese economy, the biggest consumer of commodities. As a result the commodities prices have seen a fall post yuan depreciation.
(The writer is the director, public finance and principal economist, India Ratings and Research. Views expressed are personal.)
