China’s unexpected move to devalue its currency, yuan, by a steep 2 percent has triggered speculations on the possible impact of the move on those economies that have trade links to China and are heavily dependent on export-led growth model.
Whether China’s decision to devalue currency is prompted by its weak economic growth and falling exports or part of its speculated plan to gradually open up its currency market to market forces remain a question.
What most experts agree is that for decades China's government-controlled financial markets model has indeed worked well for that country, especially when multiple financial crises swept through the rest of the world. But the recent stock market turmoil and the current phase of economic slowdown have indeed raised questions on the sustainability of this model ahead.China has maintained that the current Yuan devaluation is a one-off move, but there aren’t many takers for this promise. History shows that one cannot rule out a series of such moves, India ratings and research have said in a recent note.
Where does a devalued Yuan leave India? Industries here have raised concerns that their export competitiveness will take a hit, especially in segments like metals, steel, tyre and other manufactured products.
Also, this wouldn’t be good news to the much-hyped ambition of the Narendra-Modi government to change the country as a global manufacturing hub, replacing China. Cheaper Chinese good can flood targeted markets and relatively incompetent Indian companies will have to struggle to keep pace. China is a major supplier of manufactured products to the world, including India.
The concerns are indeed logical since Chinese exports will be cheaper and thus import pressure on countries like India can increase, putting pressure on the export competitiveness of Indian manufacturers.
According to India Ratings, India’s exports to china declined 19.5 percent on a year-on-year basis to $11.9 billion in 2014-15. Items whose exports were over $1 billion included cotton, copper and its articles, mineral fuels and oils and organic chemicals. The agency feels that the Chinese demand for Indian goods is likely to contract further due to the decline in the overall demand in the world’s second largest economy.
But, the critical point to watch here is that the yuan devaluation alone wouldn’t do more harm to Indian exports than what the global demand slowdown has already done to our export market. The currency is indeed a factor, but comes secondary.
Indian exports have anyway contracted for seven straight months mostly due to the demand slowdown globally. A weaker yuan is unlikely to spoil the show further, except in certain segments.
The bigger concern, perhaps, for the Indian central bank would be the potential impact of a depreciating yuan on the Indian financial markets and on local inflationary pressures.
Following the yuan devaluation, panic selling has brought down the local indices (Sensex) by 393 points (1.4 percent) in the last two sessions. Foreign funds have begun pulling out funds (FIIs withdrew Rs 737 crore as per provisional data in the exchanges), putting pressure on the local rupee.
The rupee fell to 64.8525 on Wednesday touching an intra-day low of 64.94 and triggering speculations that it could fall further to below 65 levels. Falling yuan would mean a depreciating rupee and some benefit to exporters, but can add to inflationary pressures.
But, even here, with the current trend of a declining rupee, inflationary pressures are unlikely to escalate sine the lower oil and commodity prices globally, will outweigh this impact, according to economists.
“Falling oil and commodity prices will offset the impact of depreciating rupee (on domestic inflation),” said Guarav Kapur, a senior economist at RBS in Mumbai. “The fact that commodity prices have come down reminds us that we are not yet in an alarming position,” said Kapur.
In fact, the Reserve Bank of India (RBI) would be happy to accommodate a weaker currency since a weak yuan adds to the real value of Indian rupee, according to a note by the DBS group.
“The yuan’s fall will add to the rupee’s strength on real basis, much to the chagrin of the Indian authorities. The rupee’s relative strength against its trading partners has been of the concern for policymakers,” the DBS note said.
“While the Indian rupee has fallen about 2-3 per cent against the dollar since beginning of last year, INR has appreciated a strong 13% on inflation-adjusted INR REER basis (RBI’s 6 currency real effective exchange rate). Rupee’s strength on real basis has mainly been a function of global accommodative policies putting downward pressure on their respective currencies, mainly the euro and JPY,” DBS said.
Thus, a falling yuan wouldn’t translate into additional inflationary pressure in the domestic market, provided the rupee doesn’t nosedive below 65 against the dollar.
But this whole assumption can work only if monsoon doesn’t play spoilsport. Otherwise, the inflation is unlikely to stay within the central bank’s comfort zone. The situation is yet unfolding.
“It doesn’t appear that there will be much of an impact on inflation from the pressure on currency given where the international commodity prices are,” said D K Joshi, chief economist at Crisil rating.
The short point is, at this stage, it appears that beyond the immediate sentiment impacts, the yuan depreciation might not be big a worry for India. How the scenario evolves from here needs to be watched though.
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Updated Date: Aug 12, 2015 13:47:34 IST