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China’s moves upset us policy plan

China’s moves upset us policy plan
Global financial markets were thrown into an unexpected turmoil over China’s sudden devaluation of its Renminbi (RMB) vis-a -vis the US Dollar on two successive days (August 11 and 12) by around 2 percent. It was the steepest drop in two decades, sending shockwaves to the world currency system and the broader economy as well. No longer the principal engine for global growth, China is now seeking to regain its export momentum and stabilise domestic economic growth with a cheaper Yuan after exports fell by 8.3 percent in July.

The Indian economy will definitely take a hit due to this decision. India’s export contraction has lasted seven months and runs a huge trade deficit with China. The latest devaluation places China in an even more competitive position with regards to India, while imports for it would be more expensive. The rupee has depreciated further in the wake of China’s devaluation. For India, however, exporting a wide range of products like textiles, chemicals, metals and consumable goods could become even more difficult in the face of cheaper Chinese exports flooding Indian markets. 

What is worse, the Yuan, as the Chinese currency is more popularly known, is expected to remain weak and volatile in the near term, though its central bank economists describe the devaluation as a “one-off” technical correction. According to them, such a reduction should not be seen as the beginning of a devaluation trend. They underline China’s commitment at keeping the Yuan stable at a “reasonable” level and strengthening the role of markets in determining currency rates. The devaluation aims at reducing the thick spread which has developed between onshore and offshore rates. The International Monetary Fund (IMF) has welcomed the new mechanism for determining the central parity of the Renminbi. The international economic organisation said that China should allow market forces to have a greater role in determining the exchange rate. “The exact impact will depend on how the new mechanism is implemented in practice”, it said.

In a statement, the IMF emphasised the importance of greater exchange rate flexibility as China strives “to give market forces a decisive role in the economy and is rapidly integrating into global financial markets”. China has been pressing for the inclusion of its currency in the SDR basket, which now consists of the US Dollar, Euro, Yen and Pound Sterling. IMF has extended its review process till September 2016, for weight and other criteria in fixing SDR rate. Its stated position at present is that a more market-determined exchange rate would facilitate SDR operations “in case the Renminbi were included in the currency basket going forward”. 

India’s Chief Economic Advisor Arvind Subramanian sees the devaluation as one having more to do with China’s growth and export <g data-gr-id="72">slowdown,</g> though policy-makers around the world have to take note of it. He also saw it as “a more plausible credible candidate for inclusion in the SDR (special drawing rights) basket”. On the other hand, there is indignation in the US over China’s devaluation, which is seen as one likely to hurt American companies. Such a move, according to certain American economists, would weigh on their sales of well-known brands to smaller businesses and could even threaten ongoing US economic recovery. Liberals and conservatives alike have angrily reacted saying China was still playing mind games with its currency.

China’s weakening of the Yuan would cause the largest economy in the world to bear the burden of an appreciating currency (Dollar), according to investment analysts and asset managers. Some have gone to the extent of viewing it as one which could lead to US Federal Reserve deferring an interest rate increase, an increase which is now considered likely only in September this year.

In a statement, the  US Treasury Department said it would continue to monitor the exchange rate developments in China and hoped Beijing would continue with its reforms aimed at rebalancing its economy shifting from exports to greater domestic consumption. “Any reversal in reforms would be a troubling development,” the department said. China’s spectacular moves are seen not only as aimed at stabilizing China’s growth at 7 percent this year and beyond if possible but also accelerating market-related exchange rate determination of its currency to qualify for inclusion in the SDR basket next year. This would help the Yuan gain the status of a global reserve asset.

A third dimension of China’s latest exchange rate move, which comes ahead of President Xi Jinping’s visit to USA, may be to reinforce China’s claims to be accorded global power status on par with the United States with which it has been seeking a “special relationship” since  he assumed power in 2013. The global impact of China’s devaluation only underlines how vital it is to reform the global order including the international monetary system.

 Also, the timing of this devaluation will have ramifications which are not only political, with the Obama Administration under Congressional pressures to get tougher with China, but also economic, in that it could impact the launching of the Trans-Pacific Trade Deal (TPT) that it has negotiated with 11 Pacific countries, none of which are China. The President is yet to overcome Congressional resistance in giving him the authority to complete the deal.
S Sethuraman

S Sethuraman

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