Calculated devaluation

When China sneezes, the world catches a cold. In a surprise action that set off shock waves across the globe and led to the currencies of many a nation taking a tumble, the People’s Bank of China cut its daily yuan reference rate by 1.9 per cent on Tuesday. Even before the rest of the world could come to terms with the unexpected devaluation, Beijing made a further 1.6 per cent cut the very next day. The moves especially had a sharp negative impact on many Asian currencies. Though the rupee too fell to a two-year low on Wednesday in the wake of the double-dose devaluation, the Indian currency has been relatively less affected compared toits Asian peers. After the consecutive cuts, the People’s Bank of China clarified that “there is no basis for a sustained depreciation trend for the yuan”. It justified the second-round cut by citing a fall in the spot market. Is the devaluation an indication of China moving towards a more market-determined currency rate? Its subsequent intervention in the spot market to quell a further fall in spot rates, however, has led to a guessing game. Nevertheless, the International Monetary Fund is optimistic that the Chinese move will let market forces have a greater role in determining the exchange rate. The timing of the action – read in the context of a decelerating economy and in the light of China's heavy dependence on exports – suggests that it is a calculated move meant to regain economic momentum. It is a win-win move for China, in a manner of speaking. After all, Beijing is also making a strong pitch to make the yuan a global reserve currency at the IMF. For that to happen, it has to move closer to a mechanism of market-determined exchange rates. 

The immediate tumble in global currencies aside, the wider implications of a largely devalued yuan on individual economies of the world will play out intensely in the minds of policy-formulators within governments across the world in the coming days. In the era of the inter-connected world, it is incorrect for central banks, especially of bigger nations such as China and the U.S., to assume that they could operate in separate silos. Given its overbearing status as an exporter, China’s step may trigger rearguard action on the currency and trade policy fronts. For New Delhi, in particular, this throws up a fresh challenge as it battles to stem a slide in exports. It has to make counter-moves to stop quickly and effectively the flooding of Chinese goods in the wake of the yuan devaluation, which could have a cascading effect on a host of sectors.