GLOBAL BUSINESS MANAGEMENT

ASSIGNMENT 2
ON
CHINESE YUAN DEVALUATION

By RAJEEV
Section B,
Roll No- 1412

INTRODUCTION

The fragile foundations of the global economy have been shaken again by the recent
devaluation of the Chinese yuan by 1.9% against the dollar. The Chinese authorities
allowed the redback to depreciate not once, but thrice in quick succession, an
occurrence that was received with a sense of shock the world over. This reaction was
another grim reminder of the fact that national authorities and the global institutions
like the International Monetary Fund (IMF) continue to suffer from their inability to
anticipate crisis situations such as the one that has been triggered by the devaluation
of the yuan. This appears rather unusual for over the past year the Chinese economy
had given enough signals that it was losing momentum, which could have adverse
implications for its currency

Slowdown of Chinas Economy

Since the beginning of 2014, there were clear signs that the Chinese economy was
slowing down, a development that President Xi Jinping wanted the world to accept as
the new normal of Chinas economy (Xinhua 2014). Until the first half of 2011, the
Chinese economy grew close to the old normal rate of close to 10%, but by the
fourth quarter of 2014, the growth rate fell to just over 7%. There was more
disappointing news in the first quarter of 2015; Chinas gross domestic product (GDP)
growth dipped below 7%, the first time since the early 2009 when the Chinese
economy was rocked by the global economic downturn.
Chinas GDP growth has been severely dented by the slowing down of its
merchandise trade. Since 2012, Chinas merchandise trade has been on a decelerating
growth path; in 2014, the growth was down to just 3.4%. During the year, imports
barely grew, while exports grew by only 6%. But very few among the policymakers
both in China and elsewhere, would have been prepared for what has been happening
on the trade front in 2015. For the first time in its post-reform phase, Chinas trade
sector is heading for a negative growth in a normal year. In the first seven months of
the current year, Chinas imports have declined by over 7.5% and its exports are down
by nearly 4%, as compared to the corresponding period in the previous year. These
numbers were possibly the clearest signals that Chinas economic woes had reached
the tipping point.

These perceived signs of economic uncertainty were fanned by the negative

sentiments emanating from the capital market. Over the past two years, China has
been witnessing outflows of capital, which, according to market analysts have grown
rapidly in recent months. The estimates of capital outflows from China vary widely,
which makes it difficult to assess the magnitude of the problems that the country is
facing on this front. The worrying sign for China is that it is facing an acute crisis of
perception arising from the negative sentiments of the fund managers. According to JP
Morgan, in the past four quarters, capital out- flows from China were in the range of
$450 billion (Bloomberg Business 2015), after adjusting for changes in the valuation
of foreign exchange reserves. The Telegraph has reported two assessments by fund
managers, which point to the broad magnitudes of the outflows. Charles Dumas of
Lombard Street Research has made an assessment that capital outflows from China
had reached $800 billion over the past year, while Robin Brooks of Goldman Sachs
estimated that the second quarter of 2015 alone had seen outflows exceeding $200
billion (International Business Times 2015). However, the veracity of these numbers
remains doubtfulsimilar estimates provided for the third and the fourth quarters of
2014 were found to be considerably larger than the official statistics provided by
Chinas State Administration of Foreign Exchange. Thus, while there are no two
opinions that the Chinese economy is experiencing capital outflows like never before,
the precise magnitude of these outflows remains debatable.

PBOCs Claim:
PBOC claims that the devaluation is all part of its reforms to move towards a more
market-oriented economy. It is also true that with slower growth in China and a
strengthening US dollar, allowing the yuan to depreciate is in line with market
fundamentals and consistent with the Chinese governments commitment to let the
market play a greater role in determining economic outcomes.

Causes and Implication:

If we will analyze chinas governments move then we can see that there are two
things that Chinas government wants very badly: first, for its economy to remain on
an even keel, keeping growth and employment high. Second, for its currency, the
Chinese Yuan, to become globally pre-eminent, helping promote the countrys
diplomatic goals and solidifying the countrys centrality to the global economy.
Frequently these goals are in conflict. So now if we will discuss based on these facts
then following point will come in to picture.

From my perspective there are two major possible causes (in the way experts are
reacting to this devaluation):
1. First one is that China is just trying to come closer to a non-fixed currency system
and that is why the Yuan had to drop vis a vis the dollar.
2. Second one is that China is just trying to boost its growth since its economy is
dramatically slowing down.
Here with the move played by china to devaluate Yuan we could also say that China is
trying to get two birds with one stone, i.e., increasing export will help in keeping its
economy to remain on an even keel, keeping growth and employment high and
making Yuan a more legitimate global currency.

First cause:
First cause is supported by the experts believes that China is just letting its currency
depreciate against the basket that the yuan is compared to. Since the basket contains
dollars, and the dollar has been so strong, every other currency in the basket has
depreciated against it, the Chinese yuan is relatively overvalued in terms of this last
currency move that started a little over a year ago. Hence, the move its not really a
devaluation but a depreciation.
China is looking to assert more of a leadership role in the global economy, and an
important piece of that is establishing the Chinese Yuan as a reserve currency. The
dollar and the euro have a reach and a usefulness far beyond the borders of the
countries that use them, and China would like the Chinese Yuan to have a similar
sway in global trade and finance, especially in Asia.
Just last week, the International Monetary Fund said that the Chinese Yuan was not
quite ready for inclusion in the basket of currencies the I.M.F. uses for special
drawing rights, a reserve asset that currently is a mix of dollars, euros, yen and
pounds. Christine Lagarde, the organizations managing director, said China needed to
make its currency more freely usable. And the policy change on Tuesday, by
moving closer to a world in which markets determine its price, is a step in that
direction.
China has said it will allow market forces to play a bigger role in the value of the
currency, which could help the country make the case for becoming a global reserve
currency.

Second cause:
Second cause is supported by the believe that the Chinese authorities are starting to
fear that the forecasted GDP growth rate will fall even more and China is trying to
boost it by manipulating the exchange rate in order to boost exports.
Chinas economy is performing worse than expected and the move is an attempt to
make exports more attractive the devaluation. Chinas currency devaluation making
Chinese exports cheaper and imports into China more expensive by that amount. And
this interpretation is supported by the fact that the devaluation occurring just days
after data showed a sharp fall in Chinas exports, so we could believe that China's
insistence that the move was motivated by market-oriented reforms is just a
convenient excuse. The Chinese government claimed that its exports had fallen 8.3%
in July from the previous year. As the news is evidence that its interest rate cuts and
fiscal stimulus were not as effective as hoped, many interpret the devaluation as a
desperate attempt to stimulate China's sluggish economy and keep exports from
falling further.
According to this cause this move was made to stop further fall of export, for
example, the euro had dropped over 15% against the dollar while the yuan remained
unchanged. When we think about the fact that Europe is the largest trade partner of
China we can see a problem here as the price of exported goods from china to Europe
will increase so demand will come down and hence export will be affected in the same
way, which is not in favor of China. Hence devaluation of Yuan is crimping China's
export to EU. So China is dropping its currency too and EU will scream "currency
war".

The Indian impact

The immediate impact is likely to be capital inflows, if continuing volatility in Chinas
markets lead to a deeper emerging markets risk-off. Selloff in Indian bonds, in the
absence of any significant buying interest, typically results in enhanced price volatility
of Indian bonds and a commensurate move in the rupee.
But the impacts go beyond markets into the real economy. Chinas role in the global
economy has increased rapidly and disproportionately in trade. Its share of world
gross domestic product was over 10% in 2014.
In exports, its share is over 15% and in importsalthough a bit lower than in 2014
is over 11%. China accounts for close to half of the global consumption of copper,
aluminum and steel, and more than 10% of crude oil.

The first, and an overwhelmingly positive, impact therefore of a slowdown in Chinas

commodities demand on India is through lower commodity prices. India imported
$139 billion worth crude and petroleum products in the 2015 fiscal, and as a rough
rule of thumb, every $1 drop in crude prices results in a $1 billion drop in the
countrys oil import bill. India also imports $3 billion of copper and copper products.
However, there is a flip side to falling commodities pricesthe effects on companies
in India operating in the minerals space, including steel, mining, selected chemicals,
and some trading companies. Many large companies in the production space are quite
leveraged, with debt-funded production capacities built up in the high-growth years.
Stress on debt servicing ability is already high, and a further drop in commodities
prices and a slowdown in exports will add to this.
In addition, it might be reasonable to expect that the renminbi depreciation will lead to
a further drop in prices of commodities China exports to India.
Indian manufacturers have already complained of non-market pricesmaybe even
dumping below costof Chinas exports to India, and a further drop in Chinas
capacity utilisation in segments like iron and steel, bulk drugs and chemicals will lead
to a further drop in prices.
Besides imports, Indias exporters will also lose out on currency competitiveness to
China in segments it competes directly with Chinaparticularly textiles and apparels
as well as chemicals and project exports.
Indias trade deficit with China has almost doubled from $25 billion in 2008-09 to $50
billion in 2014-15. And Chinas share of Indias total trade deficit is up from just
under 20% in 2009-10 to 35% in 2014-15.
There are indirect consequences as well.
China holds about $1.5 trillion of its reserves in US securities. Another half a trillion
is held by Russia and OPEC countries, whose resources too will be under stress with
falling crude prices. This has implications for US sovereign yields, already on the way
up with expectations of a rate hike by the Federal Reserve in 2015.
A move up in developed market rates will have consequences, via reduced capital
flows on emerging market yields as well and the ability of central banks of these
countries to cut rates significantly, despite slowing growth.