The Truth Behind Yuan Devaluation

Dear Readers,

Recently we came across a news where we heard that China devaluated its currency. Before we proceed with the article, let us understand what the devaluation is and what could be the implications. A deliberate downward adjustment to the value of a country's currency, relative to another currency, group of currencies or standard. Devaluation is a monetary policy tool of countries that have a fixed exchange rate or semi-fixed exchange rate. It is often confused with depreciation, and is in contrast to revaluation.

Devaluating a currency is decided by the government issuing the currency, and unlike depreciation, is not the result of non-governmental activities. One reason a country may devaluate its currency is to combat trade imbalances. Devaluation causes a country's exports to become less expensive, making them more competitive on the global market. This in turn means that imports are more expensive, making domestic consumers less likely to purchase them.

While devaluating a currency can seem like an attractive option, it can have negative consequences. By making imports more expensive, it protects domestic industries who may then become less efficient without the pressure of competition. Higher exports relative to imports can also increase aggregate demand, which can lead to inflation.

Devaluation of Yuan

China cut the value of its yuan currency against the US dollar for the second day in a row Wednesday, taking the reductions to 3.5 per cent this week — the largest in more than two decades. The move has reinforced concerns about the world's second largest economy, and analysts are divided over the reasons behind the move and the consequences it will have.The People's Bank of China (PBoC) said Tuesday's "one-time correction" in the yuan is part of a larger scheme to give the market a bigger say in the value of the currency, also known as the renminbi (RMB).

At the same time Chinese growth has been slowing, and a devaluation can boost the economy by making exports -- a key sector -- cheaper for overseas buyers. A decades-long boom has turned China into the world's second-largest economy, but despite being the world's largest trader in goods its role in the global financial system remains relatively limited. It has been looking to build up its presence, setting up a new multilateral Asian Infrastructure Investment Bank, and is also pushing to join the exclusive club of the International Monetary Fund's basket of "special drawing rights" (SDR) reserve currencies. But it must show progress on liberalising the yuan regime to win membership.

The jury is still out. For China, the move could deliver both an export and economic boost -- but will also make imports more expensive, potentially pushing up inflation, and raise costs for Chinese firms with dollar-denominated debt. For the rest of the world, some analysts believe the move could trigger currency wars, as other emerging market countries devalue to compete. Market and economic turmoil could cause the United States to delay plans to raise interest rates as the world's biggest economy recovers.

Most analysts expect the yuan to weaken further, but at a more gradual pace. SG Global Economics said in a research report that it saw a "bias for further depreciation" in the yuan, extending to five per cent over 12 months.The United States has previously criticised the yuan for being undervalued, but also hopes China will speed financial reforms and create a more level playing field for American companies. It is taking a wait-and-see attitude. The IMF, now considering China's application for SDR currency status, praised the move as giving market forces a greater role. 

India's Preparedness on This Move

Global experts have expressed extreme views on the devaluation extreme views on the devaluation of the yuan. Some have said it is more significant than the Greek crisis and the coming U.S. Fed interest rate increase. But for others,  it is small and long-overdue adjustment that barely begins

to make up for the really big recent moves in the dollar, euro and yen. “The pick-up in real credit growth and indirect tax receipts suggests that the underlying momentum in the economy is improving.” Mr. Subramanian told press persons.

The growth in underlying indirect tax collections (excluding the additional revenue from excise increases in diesel and petrol and higher clean energy cess and service tax rate) of  14.6 per cent for the first four months of the fiscal,  he said, represents a "healthy increase in nominal GDP growth”. 

He said China's surprise decision, which its Asian counterparts trade with a bearish tone on Tuesday, could be aimed at satisfying the conditions the IMF had spelt nut for granting it reserve currency status  aud inclusion in the special drawing right (SUB) basket. Arundhati Bhattacharya, SBI Chairperson, however, said: “Yuan devaluation is a challenge obviously because it makes our exports a little uncompetitive.”

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