From UPSC perspective, the following things are important :
Prelims level : What is devaluation
Mains level : Impact of Yuan devaluation
Chinese yuan broke the seven-to-one parity against the dollar for the first time since 2008. China deliberately devalued the Chinese currency after the latest tariff threats issued by US.
Why China did this
- Economic reasons
- China’s weakening manufacturing competitiveness is likely to strengthen with yuan-priced goods and services getting cheaper across supply chains in East Asia, parts of Africa, etc.
- It is likely to widen China’s trade surplus with the US in the immediate short run.
- It will also help China expand trade margins within its own region, especially with Vietnam, Thailand, Indonesia, etc.
- Political Reasons
- The US’ own strategic engagement in Asia has weakened under Trump, who questioned the “value of US alliances with Japan and South Korea
- Japanese imposed trade restrictions on South Korea. China and Russia staged their first joint aerial patrols in the region, causing South Koreans to react militarily.
- China-US friction has offered significant economic and political leverage to smaller emerging nations like Vietnam and Indonesia within their respective regional spaces
- Risk not only for those trading in the US and Chinese currencies or their stocks, but also for capital flows between emerging markets
- China, around 2015-16, tried something similar by letting the yuan depreciate; it led to a stock market crash in China, and billions of its dollar reserves disappeared in just a few days.
- That devaluation saw led to a massive capital flight from China, further weakening its external position.
- The debt denominated in foreign currencies has increased for global companies and developing nations across the world, and maybe vulnerable to a currency shock if the “currency war” continues.
- Most foreign investors switched to the safety of gold or other currencies like yen.
- China’s weakening of its currency to hurt US economic interests for political gains will only make other Asian countries more vulnerable to a political crisis that could quickly escalate to a financial crisis