Friday, August 28, 2015

The Chinese Conundrums: What and Why?

The Chinese Conundrum
The Chinese Currency Yuan has been devalued twice in last one week and there are a lot of concerns around the world including the anxiety about the imminent collapse of Chinese economy triggering a downward spiral  in the growth rate pushing the world economic environment in depression.
On the face of it, the move looks as a step to boost the country’s exports by making them more attractive for foreign buyers, thus providing an impetus to the economic growth that china has been struggling to maintain in the recent years, the same step would make the exports from other countries into china unattractive and countries like US, UK , Australia which have china as a major trading partner could see this as a warning signal leading to fall in the stock prices in these markets.
China is the second largest economy in the world after USA and any adverse movement in the economic parameters have far reaching impact across the world.  If we go deeper in the phenomenon, the devaluation could be a move towards the natural progression towards the free float system where the value of the currency is determined by the market forces and not managed by the government which is the case with Chinese currency which is pegged against a fixed basket of currencies, china may be looking at moving towards the free float system which is followed by most of the developed countries in the world. This could also be seen as a step towards getting yuan included in the basket of Special Drawing Rights (SDR) of IMF in which it grants loans to member countries.
This devaluation looks more natural than in the years around 2008 where the country was accused of keeping its currency cheaper for making exports attractive, the kind of growth trajectory that china has followed over last two decades is very difficult to sustain unless there is continuous economic activity. China has been deriving its growth from the exports where the numbers of economic parameters might not have been reported that correctly which puts a question mark on the rosy picture painted by close to the double digit growth over a decade. The next spurt of Chinese growth will come from the widespread domestic consumer spending and the measure that the government takes might be the stepping stones in this direction.
Another reason for currency devaluation could be to keep the Chinese currency competitive in such a market where major competitive currencies were losing more value and as a result Chinese export were losing competitiveness.
The move has seen knee jerk reaction from stock markets across the world with Indian bourses registering historic falls before recovering a bit, In terms of resilience Indian markets are fundamentally strong and these falls may best be considered as temporary in nature.
If we look at the movement of rupee, devaluation of Yuan has an adverse impact on the price of rupee and it has moved down, but it is still to be seen that whether it is a long term phenomenon or a one off event , in terms of export Indian exports have been declining for months, but as a result of global slowdown imports have also been declining keeping the balance of payment stable , but if the rupee movement goes out of hand RBI may have to intervene with policy measures like rate cuts to keep the fluctuation of currency in comfortable limits. Volatility in rupee may make imports costlier stoking inflation due to which RBI might have to stick to high rate regime.
While the fall in value of Rupee should help exports, it may not necessarily be true because of global economic slowdown and the fact that India and China compete for many item exports like textile, gems and jewelry etc.
What Indian Corporate sector is wary about is the possy of dumping of Chinese goods in India as a result of cheaper yuan
As for the stock markets in US , some believe it to be overvalued for a long time  so the correction is taking place for some time which has been compounded by the signals of crisis in China. Overall all now Fed is in much better position to intervene and make amends than it was in 2008 global financial crisis, the over dependence on china for trade and exports is causing some jitters in the US stock market which should even out with time.

In regards to India, the fundamentals of the economy look strong enough , Rupee with the intervention of central bank should weather the storm set up by Yuan devaluation and the possibility of currency war look like a distant possibility. With the Chinese dragon weakening in its flight, the time is ripe for Indian Elephant to move fast and attract FDI in addition to FII to strengthen the fundamentals of economy to move into decade of sustained double digit GDP growth.

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