The Devaluation of Chinese Currency

Currencies in Asia tumbled and stock markets fell through Asia after the sudden devaluation of yuan on Thursday. The South East Asian countries were hit hard, and Indian rupees further fallen against dollar.  Chinese currency – Yuan was devalued nearly 2% of previous value. It was one of the biggest devaluation since the last decade.  Economic experts gave mix opinions about its effect on global economy. Some experts suggested that it is signaling a structural problem in Chinese economy. In the long run, the Yuan may be liberalized further as China is aiming to make the currency as global reserve currency.

China doesn’t let its currency float freely in the global financial market as US does. Yuan is directly linked to US dollars. People’s Bank of China (Chinese Central Bank) sets a daily target of 2% or above band against the US$. But it was devalued on Thursday by 2% below from the Monday’s level. It created a stir in the global financial market, and major stock exchanges saw a marginal negative growth. The devaluation hit also marginally to US markets as their oil prices fell and equity market also saw a low growth on US stock exchange. Investors are in fear that this sudden devaluation move may trigger the currency war and Chinese economy might be losing its momentum. A US treasury official said any move by Chinese leadership to liberalize its currency or market oriented exchange rate will be troubling. He further added the devaluation of Chinese currency marked such a step or not, it is still not clear.It may signal out that Chinese leadership may let its currency freely float in the global trade and financial market. It means that now market forces will drive the yuan, and it will be valued on the previous day’s closing value. This move will allow Chinese currency to better reflect the market trend and investor’s outlook.

Why Now?

The Chinese economic growth has been slowing down for the last two years. China has an investment and exports-driven growth model, and now it seems this model is exhausted. The controlled Chinese currency and its link to US dollars may have resulted in appreciation of yuan, but in reality it should have been devalued. However, it is not the first time that a country has devalued its currency by 2%. For example, last year, the euro has dropped 18% against the dollar and Japanese yen by 22%. The difference is only that these currencies are driven by market forces, and adjust accordingly.

China’s long term goal

China is eyeing for dominant position in global financial market. Currently, only euro and US dollars have international significance in international trade and financing due to various reasons. China wants yuan to have a similar sway in global trade, at least in Asia.  To realize this dream, the Chinese leadership must adhere to free market economy, and let its currency to fully driven by market forces.

Yuan still has to travel a long road to become a global reserve currency. The controlled economy and interventionist policies practiced by Chinese government must go away in order to become a reliable global currency.  China wants to control its domestic economy and its currency, but at the global level it wants to create yuan as a global currency. The tight control on its currency had helped China in the past and it was the reason, Chinese economy was not hit by Global Financial Crisis 2008. But, the situation has changed as US economy is growing at a steady growth rate; the Chinese economic growth rate is moving a little towards South.  It seems that there is an opposite correlation between the two economic powers.

Other countries still hesitate to use yuan as a reserve currency. In order to become yuan as a global reserve currency, China may have to liberalize its domestic economy in the long run.

Just last week, International Monetary Fund said that renminbi (yuan) was not ready for inclusion in the basket of currencies the IMF uses for special drawing rights. Currently, only US dollars, euros, yen and pounds have this privilege.

Overall, the cheaper currency will trigger the inflation button in China, and the companies that owe money in dollars will be hard hit. So, it might start a new set of problems in Chinese economy, but this move will surely strengthen the Chinese exports.

• It may possible that Reserve Bank of India will be forced to further slash the interest rates. Probably, it may hurt the foreign investors and may see further fall in Indian rupees. There was a sentimental effect on the Indian currency as rupee’s value further fell to 64.26 against the dollar.
• India won’t be affected by deduction of yuan but, it can cause havoc in future if yuan depreciation becomes a trend.
• The Chinese devaluation of its currency is signaling out a problem in their economy. Their growth has been slowed down and exports have fallen. The positive growth in US economy may also further slowdown the Chinese economy. India can benefit from this confusing situation if the economic reforms under the new government will be accelerated.

References

• https://www.firstpost.com/business/china-devalue-currency-means-countries-2388784.html
• https://www.reuters.com/article/2015/08/11/us-china-markets-yuan-idUSKCN0QG04U20150811
• https://www.nytimes.com/2015/08/12/upshot/why-did-china-devalue-its-currency-two-big-reasons.html?_r=0&abt=0002&abg=1&module=ArrowsNav&contentCollection=The%20Upshot&action=keypress&region=FixedLeft&pgtype=article
• https://www.nytimes.com/2015/08/12/upshot/why-did-china-devalue-its-currency-two-big-reasons.html?_r=0&abt=0002&abg=1&module=ArrowsNav&contentCollection=The%20Upshot&action=keypress&region=FixedLeft&pgtype=article
• https://profit.ndtv.com/news/economy/article-how-chinas-devaluation-of-renminbi-impacts-india-1206065