Falling rupee – A dual-edged sword?

Of late, there has been a lot of talk on depreciation of the rupee. Unless you’re Marx incarnate, you better be concerned!

But is it really a bad thing?

  1. How does it impact us?
  2. What’s the RBI doing to check it?

Let’s take the help of two mind maps and attempt to solve this mystery…

The negatives

 


And now some positives


 

Got that? Let’s try to figure out why China is devaluing its currency, Yuan

China doesn’t let its currency trade freely in financial markets as the US does. Instead, it links the yuan’s value to a basket of currencies. The composition of this basket is a secret but is believed to be dominated by the US dollar. Then it restricts trading to a band 2% above or below a daily target set by the People’s Bank of China.

The People’s Bank of China affirms that it acted so because the yuan has been rising even when market forces say it should be falling!

Worried Chinese have been moving money out of the country, putting downward pressure on the yuan. Yet the yuan has remained up anyway because of its link to the dollar, which has been rising. An overvalued yuan has hurt Chinese exports by making their products more expensive overseas.

This is exactly why China is going for competitive devaluation.

But a falling rupee doesn’t always mean an export windfall…

Anup Pujari, director general of foreign trade (DGFT), calls it a myth that the depreciation of the rupee necessarily results in massive gains for Indian exporters.

For 2 reasons:

#1. India’s top 5 exports — petroleum products, gems and jewellery, organic chemicals, vehicles and machinery – are so much import-dependent that the currency fluctuation in favour of exporters gets neutralised.

In other words, exporters spend more in importing raw materials, which in turn erodes their profitability.

#2. As buyers are aware of the currency fluctuation, renegotiation is becoming a trend now.

The moment the rupee falls sharply against the dollar, foreign buyers try to renegotiate their earlier deals. As most exporters give in to the pressure and split benefits, advantages of a weak rupee disappear.

However, despite these risks, we need not worry in the CONTEMPORARY context.

Really? India has nothing to worry about! How so?

Currency depreciation is generally akin to a stimulus because it boosts net exports, one of the three main drivers of economic growth, along with consumption and investment. 

Such a policy comes with attendant risks to:

  1. Inflation through higher fuel prices
  2. Foreign exchange reserves in case depreciation gets out of control to become a free fall
  3. Impacting corporate balance sheets

The latest economic data tell us each of these risks has receded.

Let’s see how…

#1. A falling currency can be inflationary since it raises import costs.

That is less of a worry now, thanks to declining domestic inflation as well as the sharp correction in global crude oil prices. The RBI has met its January 2016 inflation target of 6% and is planning to bring it down to 5% in first quarter of 2016.

#2. The FOREX hoard has grown

RBI has been assiduously buying dollars in the spot and forward markets to build a buffer in case there is another global shock once the US increases interest rates. In other words, there is more reason to let the market determine the value of the rupee.

#3. Corporate hedging has improved

One fear, recently, was that a sudden decline in the rupee would wreak havoc in corporate balance sheets since most companies had not hedged their foreign exchange liabilities. The rupee value of their foreign exchange loans could shoot up.

RBI data show that the ratio of hedged positions has gone up sharply, from 15% of all foreign exchange liabilities a few quarters ago to around 41% in the first quarter of the current fiscal year.


This still means more than half of the foreign exchange loans taken by Indian companies are not hedged. But the direction of change is positive.

Ergo, Indian policy makers have more room than before to let the currency drift down to maintain competitiveness.


Published with inputs from Swapnil

Any doubts?


  1. Profile photo of rajiv shaw rajiv shaw

    Cud someone kindly help me undrstnd…..1) how yuan devaluation by china leads to capital outflows? 2) why d global commodity prices r low? 🙁

  2. Profile photo of Pooja Sharma Pooja Sharma

    But till now only anti dumping duties have been initiated by india

  3. Profile photo of Devesh Tiwari Devesh Tiwari

    there should be strong international regulatory body to control crazy devaluation process adopted by big economies like china.
    “devaluation of currency increases export” is biggest myth among nations ! its not sustainable growth. you may see instant surge in export but its not long term growth !

    1. Profile photo of Ankur Yarazarvi Ankur Yarazarvi

      You know there are just “integrating” with world economy.

  4. Profile photo of NITIN JAYANAND DANGI NITIN JAYANAND DANGI

    how the chinese stock market crash is related to yuan’s devalution. can it be cited as one reason leading to yuan’s devaluation

    1. Profile photo of Rini Sen Rini Sen

      Please someone answer this question. Should we also know about Breton Woods and revise the basics now?

China warns of trade war if US imposes tariffs on its goods

  1. Context: Annual trade policy agenda sent to Congress by the new US government
  2. Agenda: America is not bound by World Trade Organisation (WTO) decisions
  3. The new US policy will also strictly enforce its trade laws, which include a “safeguard” provision that allows the Washington to unilaterally impose relief “if increasing imports are substantial cause of serious injury to a domestic industry
  4. China’s reaction: China has warned of a trade war with the US if the Trump administration decides to ignore WTO rulings and unilaterally imposes tariffs on its goods
  5. China and the US are interdependent, and bilateral trade relations affect not just the two countries but the world
  6. A trade war is not in the best interests of the two countries and peoples because a trade war only does much more harm than good
  7. Background: US President Donald Trump had made some tough statements against China before and after his election
  8. He branded Beijing as a currency manipulator to gain unfair advantage from exports and even threatened to impose 45 per cent tariffs on Chinese goods
  9. China—US trade: Reached $519.6 billion in 2016, representing 207 times that of the 1979 amount, when diplomatic relations started
  10. However, the balance of trade is heavily tilted in favour of China as US exports amount to about $100 billion

Note4students:

Important for mains. Can become part of an answer to a question as to how India should balance between China-US rivalry.

G20 pact does not rule out Japan intervention

  1. Japan: G20’s agreement to avoid competitive currency devaluation does not mean Japan cannot intervene in response to one-sided currency moves
  2. Difference: G20 talks about arbitrary intervention, which is different from responding to a one-sided move
  3. Japan’s comments were based on the G20 understanding that long-term manipulation of currencies is undesirable

Remnimbi Devaluation and Stock Market Volatility

Two key drivers of the turbulent global markets are Yuan devaluation and the sharp fall in global commodity prices.

  1. Chinese central bank un-pegged the RMB from the dollar and set a lower starting rate.
  2. It was a clear signal to the market that it wanted the RMB to depreciate and it started to fall.
  3. It also triggered capital outflows and the global market volatility.
  4. Move was perceived to be a “beggar-thy-neighbour” mercantilist move, and other central banks also let their currencies fall.
  5. The voluntary depreciation is  driven by a concern about losing competitiveness.
  6. This creates problems for investors as large currency movements heighten uncertainty and leads to stock market turbulence.

What is Competitive Devaluation?

  1. It refers to a scenario in which an abrupt national currency devaluation by one nation is matched by a currency devaluation of another.
  2. Reason: The other country would not want its exports to lose their competitive value in foreign markets due to high prices.
  3. It generally happens in a country which has managed exchange-rate regime.
  4. It is also known as currency war.

China’s yuan move rattles markets, Sensex plunges

China’s surprising move to peg the yuan at its lowest value against the U.S. dollar since 2011, triggered a selloff in global markets.

  1. There are fears that it could trigger competitive devaluation among emerging economies.
  2. The depreciation of Yuan is following the course, as it becomes increasingly market linked, following its induction as a reserve currency by the IMF.
  3. Officials stressed that India has the inherent resilience to deal with such emerging challenges.

Let’s know about Special Drawing Rights(SDR)?

  1. The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.
  2. Its value is based on a basket of 4 key international currencies, and SDRs can be exchanged for freely usable currencies.
  3. SDRs are the IMF’s unit of account restricted to its members.
  4. Today the SDR basket consists of the euro, Japanese yen, pound sterling, and U.S. dollar.

What are the disadvantages of dollar’s hegemony in world?

  1. The world financial order is heavily skewed in favour of the dollar.
  2. About 62 per cent of international currency assets are held in dollars.
  3. A miniscule rise in the American interest rate or even a talk about it is enough to cause huge upheavals in the markets of developing countries such as India’s.
  4. There are limits to the Federal Reserve’s capacity to meet liquidity shortages in the global economy.
  5. The American political system is dysfunctional.

Implications of yuan’s rise

The expectation that the yuan or the renminbi will acquire reserve currency status is no longer a pipe dream.

  1. The International Monetary Fund (IMF) is poised to approve the inclusion of China’s renminbi (or yuan as it is called) as a reserve currency.
  2. When the yuan is formally inducted into the SDR portfolio, it will be the first new currency to be so honoured since the euro was created.
  3. The important advantage accruing to China is the flexibility in settling all its international obligations with its own currency.
  4. For other countries, the benefit in having another reserve currency is that they can diversify their forex reserve portfolios to include renminbi.

G-20 discussions set to focus on impact of yuan devaluation

  1. Competitive devaluation of currency is a major threat to the stability of the global economy.
  2. Economists pointed out that, Chinese devaluation is not of serious consequence to the Indian economy, even in the medium term.
  3. The conference will analyse collaborative measures like developing global safety nets to guard nations from negative spillovers.
  4. The recent devaluation of Chinese currency Yuan has triggered a global financial turmoil, hurting stocks and currency markets worldwide.

Go ahead to check major economic group G20. How it will play crucial role to stabilize Global Economy?

Experts divided on impact of Yuan’s devaluation on Indian exports

  1. Some believe that the export competitiveness factors are beyond currency movements.
  2. While others are of the opinion that India can maintain its competitiveness if rupee also declines.
  3. The risk for India comes from two ways: one cheaper imports from China affecting domestic companies and second it would affect India’s exports to other countries.
  4. There have been increased imports from China despite a significant appreciation of the Yuan versus the rupee in the past and experts believe that India should focus on policy related efforts in boosting competitiveness.

Calculated devaluation by China

  1. The People’s Bank of China’ consecutive double cuts with 1.9% and 1.6% has sent shock waves around the world.
  2. This double dose had a sharp negative impact on many Asian currencies.
  3. Rupee too slipped down to its 2- year low level, but relatively less affected as compared to its Asian peers.
  4. IMF is optimistic that the Chinese move will help achieve market determined exchange rates.
  5. However, the context of cut is based on the premise of their decelerating economy, due to its excessive dependence on exports.
  6. This step can also be read in light of making Yuan a global reserve currency at IMF.

India steels itself to face impact of yuan devaluation

  1. Chinese decision to devalue Yuan will hurt Indian exports as it makes Chinese exports cheaper.
  2. In wake of this, India increased the import duty on certain steel products by 2.5 per cent.
  3. Reason being that prices of imported steel are up to 20 per cent lower than those of domestic products.

Experts believe that the Chinese move could be to satisfy the conditions the IMF had spelt out for granting it reserve currency status and inclusion in the special drawing right (SDR) basket.

 

China devalues Yuan by 1.9%

  1. China, which runs a ‘managed float’– i.e, an exchange rate that is managed against other currencies, pegs the yuan against the dollar each day.
  2. China announced that its daily fix will now be based on the closing rate of the interbank forex market from the previous day.
  3. The move is likely to be viewed as the govt intervention to boost the economy as a reaction to the slump in exports, and a recent stock market decline.
  4. Besides worsening the already declining Indian exports, the Chinese move is also expected to widen the trade deficit with India.


:( We are working on most probable questions. Do check back this section.







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