Financial Economics CIA

The devaluation of the Yuan: Causes effects and ramifications

The financial world this month has been abuzz with markets across the globe sounding cries
of alarm over the devaluation of the Chinese Yuan .Widespread ramifications were
suggested by forecasters ,immediately reflected in the form of various falling currencies and
widespread fears setting off world financial markets in a frenzy.

Beijing had spent much of the last year strengthening the Yuan to combat capital outflows,
and win a place among the International Monetary Fund’s (IMF) five reserve currencies. But
with growth taking a downturn and deflation looming, China reversed course, cutting its
daily reference rate to 1.9%, the most in two decades. The Chinese government has
effectively admitted that this devaluation is fuelled by the accelerated impacts of risk in the
economy. With the rise of the Chinese economy as a force to reckon with and given the
gargantuan amounts held by it in terms of foreign exchange reserve, the ramifications of this
devaluation effort has set analysts digging in to the probable impacts of this action and a
survey into the factors that have caused China to take up this extreme measure after a
climbing Yuan, last year.

Behind the devaluation

The primary speculation and the most natural one, regarding the downgrading was if it was a
part of Chinese attempts at a currency war. The criticism was levelled on the lines that
Beijing was unfairly supporting its exports, thus driving out other participants by a method of
competitive pricing. The Yuan traded in China hit a low of 6.4510 per U.S. dollar, its lowest
since August 2011, and the currency fared worse in international trade, touching 6.59 to the
dollar. Figures like this, added fodder to the fears of a currency war strategy, adding to the
rising panic in global financial markets. Companies that actively engage in trade with Beijing
have started taking stock of the situation on the ground.

Lerato Mbelee from BBCs African business report says that since Africa is now the biggest
trading partner with China and as most African nations transact in Chinese Yuan for the easy
conduct of business, the purchase of anything in terms of dollars will become expensive with
the devaluation. Brazil, already faced with a devaluation of almost 23 % in terms of its
currency in the current year, due to the slowdown of the Asian economies, which are its
biggest trade partners, will be hit harder though the erosion of value of the Yuan comes only
up to 3%.The devaluation was hence deemed as a move to improve the stance of the Chinese
exports by making them cheaper than equivalent exports from other countries and to hence
capture the market which was in a state of lethargy since it took a beating earlier this quarter.

This allegation of a currency war around the bend is aggressively used by republic president
hopefuls in the United States like Donald Trump. A section of analysts however are in
disagreement with the theory. China’s devaluation was puny", says Benjamin Cohen,
professor of International Political Economy at the University of California. He is of the
opinion that, had China possessed motives of creating a currency war ,it would not have
settled with this kind of a modest adjustment. Considering a trade weighted measure, the
Yuan(Renminbi) was strengthened by 50 percent since 2004.The recent devaluation was too
small to make a dent in this appreciation. The authorities in this case were forced to buy up
the currency and stem the decline, within a few hours post the deflation. By lieu of these
statistics, it is possible to say that the Yuan devaluation isn't the result of a currency war.
Irrespective of the scale of the devaluation, the tremors were felt in every economy engaged
in trade with China. This takes us in pursuit of the real interests and reasons behind the
devaluation .

Domestic factors

The Chinese currency has effectively strengthened against other Asian currencies in the last
12 months - by more than 10%. This makes Chinese goods more expensive abroad. Shock
emerged when figures emerged showing that exports slumped by 8.3% from a year ago.
That's worrying news for Chinese factories, which in turn provide jobs for millions of
Chinese villagers. Economists say the government may be trying to avoid job losses at these
factories by weakening the Yuan.
Also, this measure seems to arise from a requirement to correct the damages done by a real
estate bubble in China. Clocking 10 % average growth for the last two decades the Chinese
economy has reached its saturation point it . The economy is heavily dependent on exports
unlike Indian economy that depends on domestic consumption. The recent fall in shanghai
stock exchange and Hong Kong stock exchange is an output of real state bubble burst. The
Chinese government tried infusing capital in the market but this failed to boost the economy ,
So the government decide to devalue its currency to boost the export and give a trust to
economy.

Contrary to all these reasons which reflect damage control by a method of strengthening
exports, there is another reason which reflects the ambitious pursuit of world prominence by
the Yuan. A reserve currency is a currency maintained by countries as a part of their foreign
exchange reserves. People who live in countries that issue the reserve currency can buy
imports and borrow across borders at much cheaper rates, because the currency in which they
transact don't have to go through exchange rate constraints. A basket of reserve currencies
consisting of the Dollar,Euro,Pound Sterling and the Yen is called the SDR(special drawing
rights).China has been lobbying hard with the IMF to get the Yuan included in the SDR list,
as it would give it a better say in the international financial system. A standard chartered
report says that more than 60 central banks currently invest in the Yuan giving it a stance of
global relevance. A liberalised Renminbi will be closer to a market determined value, which
is a prerequisite for its inclusion in the SDR. Inclusion in the SDR list is subject to the free
usability of the Yuan which is possible a little more, following the devaluation. This move
from a currency peg to managed float will take the renminbi a step closer to being a global
reserve.

The Chinese devaluation simply reflects a short term hardship for long term stability.IMF
has put off the inclusion of the renminbi in the SDR at least for a year, to enable inclusion
only after ensuring better presence and free usability of the Yuan in the international financial
market.

Impact on the Indian economy

Forecasters in India were keen to analyse the impact of the sudden devaluations on the Indian
market, which has been trying to make a foray into the world stage following some ambitious
programmes by the government. On the surface ,this move definitely seems to break Indian
exports which will face competition from still lower Chinese exports. Domestic players will
also face the brunt of cheaper Chinese products in India. India's much touted "Make in India"
programme is also expected to take a beating due to higher cost of excessively imported
commodities like steel and also companies that decided to relocate from china to India , doing
a rethink due to the cheaper access to business. India has scaled up its import duties on
products like steel to deal with this scenario.However,some analysts also see a silver lining in
the devaluation. Companies that use Chinese products an inputs to their
industries(pharmaceuticals) will benefit at the cost of cheaper inputs. The weaker Yuan
would also help make China's exports more competitive, which would likely help boost the
nation's economy and eventually prompt a recovery in economies from where China imports,
one of which happens to be India.
The long term ramifications however can only be predicted by waiting and watching as the
Yuan moves closer to having a reserved spot in the basket of reserve currencies.

Conclusion
Though the Yuan seems to have stabilised temporarily, putting to rest fears of a continued
fall, it needs to be observed, how the Yuan does following the Chinese pursuits at structural
reform by moving from a fixed currency regime to one that is determined by market
variables. By this exercise, it is also possible to survey the efficiency and fallacies associated
with currency devaluation as a tool of managing exchange rate, with the RBIs philosophy
being to make the exchange rate market determined and to practise slow measured
depreciation ,rather than sudden artificial devaluation in times of crisis. All these factors
make this incident of devaluation a crucial topic of study to forecast the future of the
emerging Asian economies.

Bibliography
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