Impression of Chinese Yuan on Indian economy

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China stunned the world's financial markets in August 2015 by devaluations of yuan  knocking off 3% of its value. The move was unexpected and many believed it was a desperate attempt by Chine to boost exports to support the economy which was growing at its slowest rate in decades.    

There was another motive for China's decision to devalue the yuan i.e. China's determination to be included in the IMF's special drawing rights (SDR) basket of reserved currencies. The SDR is an international reserve asset that IMF members can use to purchase domestic currency in foreign exchange markets to maintain exchange rates. IMF reevaluates this currency composition in SDR basket every five years. In 2010, yuan was rejected on the basis that it was not freely usable. Later, IMF welcomed the devaluation since it was claimed of being done in the name of market-oriented reforms. Consequently yuan became part of SDR in 2016. 

Within the basket, Chinese renminbi (system of currency of China introduced in 1948 - another term of yuan) had a weight of 10.92%, which is more than the weight of Japanese yen and British pound. The rate of borrowing funds from IMF depends on the interest rate of SDR.  As currency rates and interest rates are interlinked, cost of borrowing funds for its member nations would now hinge in part on China's interest and currency rates. Many doubted China's commitment to free- market values since the devaluation occurred just days after data showed sharp fall in China's exports -down 8.15% in July 2015 from previous year. 

China's economy depends heavily on its exported goods. By devaluing the currency, China lowered the price of its exports in order to gain competitive advantage in the international markets. Weaker currency made, on the other hand, made China's imports costlier, thus spurring the production of substitute products at home to aid domestic companies. 

US Govt. claiming that China had kept its currency artificially low at the expense of American exporters, also believed the beginning of currency war that could increase trade tensions. The Chinese yuan generally depreciated against the US dollar between 2015 and 2019. 

EFFECT ON INDIA 

India and China officially resumed trade in 1978. In 1984, two sides signed the Most Favored Nation Agreement. Subsequently, China became the largest goods trading partner with India - has a whooping trade deficit in 2014-15 on account of rising imports with weak export dynamics. 

The devaluation of yuan will not have a significant effect on Chinese exports as the currency is still highly overvalued. On the other, Indian rupee also lost some value against the US dollar following the decline in yuan, thereby supporting a modest short-term impact on India. If this adjustment of currency continues then Chinese exports will increase as they become more competitive. This will have negative impact on India exports.  Further, there will be an influx of Chinese goods in India,which will result in widening the already rising trade deficit with China.      While India is struggling on the domestic front with legacy issues like infrastructure and stalling of key legislation, a loss in currency competitiveness against yuan will further hit its ailing exports.   

A devalued currency make the exports look attractive. This means Indian exporters will face a higher competition in the international market. A drastic fall in exports could lead to a wider trade deficit - when India buys more from the world than it sells. A weak Chinese currency could hit Indian exporters further.

The threat of greater emerging market risk due to yuan devaluation led to increased volatility in Indian bond markets, which triggered further weakness for the rupee. Usually, a declining rupee would aid domestic Indian manufacturers by making their products more affordable for international buyers.  

A Chinese devaluation has scared foreign investors who may flock to India looking for better results. A depreciated currency shrinks the dollar value of the investments at the time of repatriation. While fear of further devaluations continued on the international investment scene for another year, they faded as China's economy and foreign exchange reserves strengthened in 2017.  The negative impact of currency devaluations on relations with U.S also contributed to China briefly labeled as currency manipulator in 2019 and early 2020. 


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