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simple question to begin with; What actually is devaluation?

Devaluation means a deliberate reduction in the value of a currency, in comparison to another currency, by the central bank of that country. This policy is usually adopted to increase the exports of the domestic country. This policy has been adopted by many countries from time to time. The Peoples’ Bank Of China (PBOC) surprised everyone by devaluing the Chinese Yuan by 2% on August 10, 2015. To understand this move, we must first understand a bit about the policy used by China to determine their foreign exchange rate.

Before the devaluation, PBOC used to determine the exchange rate every day, without paying much consideration to the events of the previous day. However, after the first devaluation on 10 August 2015, the PBOC decided to let the market forces affect the exchange rate of Yuan, instead of controlling the rate themselves. This led to a further fall, and Yuan fell by 5% over a period of just three days. In December 2015, China introduced a new exchange rate index, that valued the Yuan against a basket of 13 trade-weighted currencies, which was read at the time as the country preparing for a stronger dollar as the U.S. Federal Reserve began hiking interest rates.

This devaluation should not have had any big impact, as other major currencies like Yen and Euro had also taken similar hits in a short time period, but it had a very big impact globally. The shockwaves of this move were felt globally. The Yuan used to be associated with stability, as it would move only by a few hundredths of a % against the dollar in a given day, and 0.16% had been the largest single day shift in 2015 till devaluation. The investors worldwide were left in a state of shock. This move by China led to large-scale capital outflows. The world had not yet recovered from this move when China devalued its currency again on 11 January 2016.

Various reasons and justifications have been given by different economists. The Chinese economy had been registering double-digit growth rate for many years (except 2008). However, since 2011, their growth rate had been on a decline. They were struggling to meet the targeted 7% growth rate (their growth rate was 6.80%). The main reason for this growth had been Chinese Exports. They became the second largest economy in the world and their exports were one of the important reasons for that. The Chinese exports tumbled by around 8.30% in July 2015, which was a pretty significant drop for such a large economy. They needed to do something really quickly to increase their exports. They made frantic and desperate efforts to boost their growth by encouraging consumer spending and the services sector. The fall in the value of Yuan made the Chinese goods cheaper in the international market and this promoted their exports. Earlier, the goods of regional rivals (South Korea and Japan) were getting cheaper and this was harming the Chinese Economy.

The stock markets globally were affected by this move. In China, trading was suspended for the entire day after half an hour of the opening of the market, as the SSE Composite Index (Shanghai Stock Exchange) fell by 7%. The U.S. stock markets, including the Dow Jones Industrial Average (DJIA), S&P 500 and Nasdaq and various European and Latin American markets fell in response to the devaluation. Sensex (BSE) fell by close to 550 points amidst this crisis. Commodities like Gold were also affected and the prices slipped to a four – year low. In a similar manner, the price of other currencies was also affected in a negative manner. The Singapore dollar sank to a six-year low (S$1.43, a fall of 7.4%) against the US dollar, while the South Korean fell to a four-month low. The INR also fell to a two-year low and it remained low throughout the latter part of 2015. What happened was that the investors globally started buying dollars as soon as the Yuan lost its value and the price of other currencies fell.

The weaker currencies helped the exporters to compete with the cheap Chinese exports, but the buying power of the consumers and the different companies were badly affected by the devaluation. When China sneezes, the global economy could catch a cold. The weaker yuan was bad for the export-oriented economies (which majorly export to China) like Singapore, Hong Kong, South Korea, Taiwan etc. as the imports in China became more expensive. Bloomberg found that profits of 800 Non-Chinese Asian Companies, which gather 80% of their revenue from China and Europe, fell by $5 b or by 10% (from $50 billion in 2013 to $45 billion in 2015). The burden on Chinese companies, which owed money in dollars, increased tremendously. They had to now shell out more money to repay their debt.

This gave a signal to the world that China was panicking and their economy was underperforming. US president Donald Trump has been voicing his opinion continuously that China keeps the currency artificially low to help its manufacturers. According to him, China not only wants to help its exporters with a cheaper currency but also wants a stronger currency to prevent capital outflow. China is the leading consumer of commodities like copper and aluminium. In expectation of a Chinese slowdown, the price of copper fell to a 6-year low and the price of aluminium fell to a point below the cost of production.

Indian exports to China fell by 20% on a year-on-year basis (fell from $14.8 billion in 2014-15 to $11.9 billion in 2015-16). China is among the top five destinations for Indian products. Due to a fall in the value of rupee, exports should have increased, but the decreased consumer spending in China meant that India could not make full use of this opportunity. Further, India also had to compete with China in global markets as both the countries deal in many common industries (textiles, chemicals, metals etc.). In some cases, China could provide the goods at a cost which was lower than the cost of production of Indian manufacturers. Due to this fall in the value of rupee, the prices of crude oil also increased and this led to an increase in the overall price level.

In addition to causing damage to economies of different countries, China also lost out on certain things due to this policy. The weaker yuan has cost China billions of dollars of foreign investment. China has $3 trillion worth of reserves still available to them. However, they spent $473 billion from August 2015 to June 2016 just to defend their exchange rate. The expensive imports had a role in increasing inflation in the country (the inflation rate per month continuously rose since October 2015 for 7 months).

As per my opinion, this Chinese policy has not been instrumental at all, as the growth rate of the Chinese GDP has fallen from 6.9% in 2015 to 6.7% in 2016. The exports from China have decreased further in 2016. The consumer spending has fallen by an even greater margin. This move has caused more harm to other economies globally. The exporting nations have been hit. Their growth rates have been very low. China still does not allow the value of its currency to rise and the world has started accepting the fact that Chinese yuan is undervalued.

By Sanat Goel


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