Currency Devaluation by China - Causes & Effects

Currency devaluation by China - Causes and effects
Currency devaluation is the most talked about topic in the recent months.The 3 % devaluation of Yuan by China - the world’s second largest economy - has created havoc in the world. Japan too has devalued the Yen to its 40 years low. Tracing back to 2013 we had the currency war. After all what is currency devaluation? Devaluation is the “deliberate” downward adjustment to the value of a country’s currency. Now the word deliberate excites us. Why would a country like to deliberately reduce the value of its currency relative to another currency?
Well there are many reasons behind it. One reason is to combat trade imbalances. When a country devalues its currency, exports receive a boost. The economy promotes its domestic industries as imports become costly. Another major objective is to maintain growth levels and generate employment.

While currency devaluation seems as an attractive option, it has negative aspects also. The price increase for imports can harm the citizens’ purchasing power. It can also lead to a currency war, whereby the policy can trigger retaliatory action by other countries which can lead to a general decline in international trade harming all countries.
So now the next question that comes in our mind is why did China devalue the Yuan? China has been accused of hiding its true intentions with the exchange rate moves. Plenty of reasons have been proffered over China’s true motivations. Many have suggested that the Public Bank of China is playing a ‘smoke and mirrors game’ to slowly engineer a more competitive Yuan. But the plausible reason is also the most prosaic. China has long sought the official currency reserve status as bestowed by the IMF through its ‘special drawing rights’ (SDR) basket of currencies. The pound, Yen, Sterling and Euro currently make the SDR. Liberalization of Renminbi, so that it can move towards a more market determined value, has long been a pre-requisite for its inclusion in the basket. In shifting from a currency peg to a market float, Beijing took its first step towards becoming an official global reserve. According to another school of thought, the reason behind the devaluation seems to be that China wants to increase its exports as it is finding it difficult to achieve even 7% growth rate. Increase in employment and growth have been identified as its motive. One possible reason for this move may be that China is indulging in the ‘beggar –thy –neighbour ’ policy whereby one country tries to remedy its economic problems by means that tend to worse  the economic problems of other countries. It might be planning to shift the effective demand away from imports onto domestically produced goods by competitive devaluation or currency war. That’s a worrisome trend across the globe because there is only so much global demand and if we all are trying to capture it by devaluing our currency, then it becomes free for all.
Whatever be the reason for devaluation, - the Public Bank Of China move will encourage Asian Central Banks that are close trading partners with China to follow the suit. Devaluation hurts the countries that export large amount of commodities and manufactured goods to China. Big exporters of soya-bean, coal, nickel, iron-ore, etc.such as Brazil, Australia and Indonesia are hurt because a weaker Yuan further pinches Chinese demand for commodities. The Australian dollar fell for more than 1%. The value of Yen – the currency of the world’s third largest economy, Japan, has reached its 40 years low.
So can we conclude that China is indulging in a currency war? Is the devaluation a result of currency war or frustration on the part of Chinese authorities in the face of latest weak export numbers? If China had devalued the Yuan by 10% or more, it would clearly be an effort to boost exports for its advantage. A2% devaluation is different as it simply keeps the Yuan a little more in line with trading partner currencies which have lost value against the US dollar.
After gaining a worm’s eye view of the entire situation we realize that China is no longer willing to withstand a relatively stronger Yuan which has been on an upward trajectory against the dollar for a decade amid slowing economic growth, weak consumer prices and anemic exports.
Whatever be the reasons for China to devalue its currency, a developing country like India, cannot be a silent observer. During the last few months large volumes of Chinese goods have entered the market. Indian economy has also been significantly impacted. China’s devaluation of Yuan is not a concern per se but there is a danger of tit-for-tat actions by other countries if the move was a part of long term competitive devaluation. This is triple whammy. Firstly, it has lead to high rupee volatility. The rupee sank to its two year low of Rs.64.95 per dollar. Secondly, India’s export to other countries experienced a downward pressure. Thirdly, our imports have increased due to the dumping of Chinese goods in India. All this has lead to a selling pressure in the domestic stock markets. Our domestic industry has suffered material injury.
 Our Government should be proactive in taking the necessary steps on a war footing. The immediate need of the hour is to levy anti-dumping duty and in cases where anti-dumping duty is already in place, it should be revised upwards suitably. For the environmental changes over which we have no control, the only thing left for us is to respond to the changed scenario as fast as possible. In a rapidly changing world, superfast adaptability is the mantra to keep alive and to grow.

Sai Praveen

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