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6 things to know about China currency devaluation
The Indian stock market has had a rough few days. And now, there is an additional reason for the choppy performance. China, on Tuesday, announced a 2% devaluation of its currency. Soon enough, its currency, the Renminbi, fell to a three-year low. This was the biggest one-day fall in a decade. The Renminbi may be the name of the currency, but it is measured in yuan. So for exchange rate purposes, it is the yuan that is used.
In a globalized world like ours, such a massive fall in a major economy's market always causes ripple effects. The Indian rupee and stock market too reacted negatively to the news. This is because the devaluation has the potential to affect Indian economy.
The Chinese move has left several questions in its wake. Here are answers to six important questions you may have:
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Can China do that?
Yes it can. Every country has a different policy for its currency. Some countries have a no-interference policy. They let the market participants decide the currency exchange rate. Some countries like India set target rates for its currency. Depending on the volatility in the market and the exchange rate, the central bank-RBI in this case-buy or sell rupees in the market to direct the exchange rate. Other countries, like China, decide a particular exchange rate against the dollar. China then allows the yuan to move 2% above or below this exchange rate. This is fixed on a daily basis.
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How China devalued its currency?
On Tuesday, the Chinese central bank pegged its exchange rate 2% higher than the previous day. It has since weakened over 3.5%, as of August 13. This means, you need 3.5% more of the Chinese currency to buy a single US dollar. Not just that, the central bank, the People's Bank of China (PBOC), also indicated that the currency could fall further down.
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Why did China devalue Renminbi?
The official statement says that market forces led to the devaluation of the yuan. However, a closer look at its macro-economic data suggests a different answer. The equation is simple; a weak currency is good for exporters. It makes your goods cheaper when converted into US dollars. So, a buyer is more likely to buy the cheaper goods, thus boosting the country's exports. China wants to increase its exports. Its exports fell 8.3% from the previous year as per July data. Moreover, its economy has slowed down considerably in the recent years. A growth in exports could help the Chinese economy grow faster.
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How is it going to affect India?
A devalued currency makes the exports look more attractive. This means Indian exporters will face a higher competition in the international market. Indian exports have struggled in the past few months. In fact, exports fell for seven straight months to June 2015. A weak Chinese currency could hit Indian exporters even further. A drastic fall in the exports could lead to a wider trade deficit-when India buys more from the world than it sells. This is not good for the economy. Moreover, the Chinese devaluation could cause a currency war amongst countries, who could all try to weaken their currencies. This is not good news.
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Is there a silver lining?
China is one of the biggest commodity importers in the world. In the recent past, Chinese demand has been subdued due to the economic slowdown. Whenever demand slows, prices fall too. This is the reason why the international prices of key commodities like copper fell in the last few years. This benefits India, which also imports many of these commodities. This fall in prices reduces India's import bill. That said, this is not good news for Indian steel companies and commodity exporters. Secondly, foreign investors could exit the Chinese market if they expect the yuan to depreciate more. In such a case, they may look towards India as an investment destination. Any foreign inflows boost the Indian markets.
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How does it affect Indian rupee?
The Indian rupee fell 0.8% after the devaluation. Usually, a weakening of the rupee causes great worries. However, this time, the weak rupee helps shield Indian exporters from the devaluation. The Indian currency was already weaker by over 4% from the last year. As of August 13, the rupee is down nearly 6% on a year-on-year basis. This makes Indian exports competitive.
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$195.097 billion
China exported goods worth $195.1 billion as per July 2015 data. This is slightly higher than the $192 billion in the month June. However, it is nearly over 8% from the year ago, when it exported goods worth over $221 billion. As a result, its trade surplus-when exports exceed imports-narrowed to $43 billion from $47 billion in June.
