A stronger yuan cannot hurt India much. In fact, it could help India in exceeding growth targets of 2010-11.
The talking point of the past fortnight has been the Yuan's impending revaluation. This has large long-term implications. First, it underlines the growing clout of Chinese policy-makers and all the attendant geo-political implications.
The economic consequences of a higher yuan would be that Chinese exports become more expensive while imports by the PRC (People's Republic of China) become cheaper. Other nations therefore, have a better chance of competing as exporters.
This could induce some shift in global trade balances since the PRC is the largest exporter. With specific regard to the US, a higher yuan should slowdown US imports and therefore, cap the American trade deficit. That gives the world's largest economy a shot at faster, sustained recovery.
It should be noted that the yuan's value will not see dramatic one-step change. The Chinese have made a statement of intent that they are prepared to let the Yuan rise. In essence, the Chinese are trying to “talk up” the global economy. How much higher and over what timeframe they will let the yuan rise is up to them. The currency is not free-float and the PRC has ample reserves to nudge any free-float currency in any direction it wants to control yuan appreciation.
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Why has the PRC done this? The answer is in several parts. One intangible is that the PRC may be flexing its muscles to see how much of a positive reaction it can elicit. At another level, China is the largest investor in US government debt and the US' largest trade partner. It has a vested interest in not killing the golden goose and the Chinese appreciate the US is in a very tight spot.
Another partial answer is that in the past three years the Chinese have shown some desire to switch from a totally export-driven economy to one with higher domestic consumption. The global recession hit the PRC hard in terms of social pain. Thousands of export-oriented factories and small units shut down and there was industrial unrest across all growth centres.
The immediate response was pump-priming through higher government spending; the Olympics helped. But the PRC seems to have decided that a higher level of domestic consumption would be healthy. A stronger currency will help that. The PRC may also have calculated that the negative impact of a stronger currency on exports is temporary. China is a huge commodity importer, especially of energy and metals. A large chunk of those imports fuel value-added exports. If commodity imports get cheaper in yuan terms, China may be in a position to reduce costs on its exports despite the stronger yuan.
There are several areas of direct impact for Indians. Exporters such as textiles manufacturers are hoping that they would become more competitive versus China. The metals market is also adjusting to the prospect of higher commodity imports by China. Higher metals prices (in USD terms) is perhaps good for India since it has significant metal-producers. But energy prices could also soar - the Indian government's recent partial deregulation will ensure further price increases pass on.
Figuring out where the rupee will go as the Yuan revalues, is tough. In practice, the yuan is tied to the USD and so, the USD is liable to see some strengthening against other currencies such as the Euro in “sympathy”. That could help Indian exporters. But this is guesswork - one could make a case for the hard currency forex market moving in almost any direction.
A trader should be looking at higher volatility in the key sectors rather than clear trends at this instant. As to trends, the global economy appears too messed up and fragile for a simple statement of intent to trigger a major recovery.
But trading volumes are likely to rise in metals, textiles, and energy shares. Prices could be choppy or move in either direction but the daily high-low ranges will increase. At the short end of timeframes, for a day trader, or a position trader with strong nerves and adequate margin, this could be exploitable.
Net- net, a rise in the Yuan cannot hurt the Indian economy much. It can help in several ways, and help enough perhaps to help India exceed its growth targets for 2010-11. However, the impact may not necessarily be favourable for the stock market. Inflation will stay high since crude prices don't seem to be coming down. That could mean higher interest rates and muted stock market prices.