The Yuan effect: Pursuing economic reform or global leadership ambition?

By Gaurav Sharma

On Wednesday, Yuan–the Chinese currency fell to a four year low, sparking global panic in the financial markets. World currencies including the Indonesian rupiah, Singapore dollar, Taiwan dollar, Philippine peso and the Indian rupee declined under the cascading effect of the fall in Yuan.

The devaluation of the Yuan was part of China's response to its tepid growth rate and slowing exports and was favored by the International Monetary Fund (IMF) as a "welcome move". Meanwhile, the Indian markets, like its international counterparts tumbled down sharply in the aftermath. The BSE Sensex, the Indian benchmark index plunged 354 points to close at 27,512, its lowest point in two weeks. The rupee shed 59 points to nearly touch its two-year low of 64.78.

In contrast to IMF's findings, the devaluation has raised concerns over a brewing global currency war, with accusations being hurled at China for "unfairly" supporting its exporters.

The valuation of currency is determined vis-a-vis the US dollar and all emerging market currencies have nosedived against the global currency standard.

"The rupee is facing competitive devaluation pressure due to devaluation of Chinese Yuan. At a time when the Asian and other global majors are depreciating their currencies to safeguard the export market and the economy, India, with a strong currency is at an economic disadvantage", says Anindya Banerjee, Vice-President at Kotak Securities.

China is India's largest trading partner and accounts for a huge chunk of its trade deficit ($48.5 billion). As such price fluctuations in currency rates do not have a direct bearing on the exports, but the loss in competitiveness along with the surge in hedging costs definitely dents overall export scenario.

China contends that the devaluation is only a one-time affair intended to make yuan more responsive to market forces. However, most market players are apprehensive as to the Chinese claims. Exporters fear more measures might be under the works.

According to Ajay Sahai, director general of Federation of Indian Export Organizations (FIEO) estimates that each percentage fall in the rupee negatively impacts exports by 0.3 per cent.

However, economists believe that there has been little or no co-relation between export growth and rupee depreciation. Global demand is thought to be a more credible factor in driving export growth while currency movement plays only a small part.

"The exports have lost competitive edge due to non-price factors such as competitiveness, logistics and infrastructure", says DK Joshi, chief economist at Crisil.

Still other feels that the decision has more to do with the recent crash in Chinese stock markets, which had sparked suspicions on its fundamental resilience. Some believe that the liberalization of the Chinese currency is in line with its long-term plan to cement its place as the global reserve currency, either with the US dollar or as its replacement.

However, as per official data from the Bank for International Settlements suggest that the Yuan was indeed overvalued. Last year in June, it was up 14 per cent. A year earlier, the figure was up by 20 per cent.

In light of the weakness witnessed by China in the past few weeks, it is but natural for China to take corrective measures. The long-term implications of the steps are also clear, to give Yuan a global face-lift. A bold move indeed by Beijing.