)
Last week, Chinese authorities ‘devalued’ the yuan’s exchange rate on three successive days: the aggregate change is about 3%. Both the Indian stock and currency markets reacted, with the rupee depreciating to cross the Rs. 65/$ level. There were official reactions to the Chinese action, with the Commerce Minister describing it as a “serious issue (which) could lead to a situation where China will dump goods into India”. The Finance Secretary, in an interview on CNBC, claimed that, as for the rupee’s fall, “the market finds a rate….. such that exports are not adversely affected” (Mint, August 14).
Neither had anything to say about the double digit fall in exports over the last eight months, about the fact that our exchange rate is not really market-determined given RBI intervention, about the fact that in terms of the RBI’s real effective exchange rate index the rupee was overvalued by 25% even before the Chinese move. It almost seems as if our policy-makers believe that the yuan’s exchange rate is more relevant to our exports and imports than the rupee’s!
Neither had anything to say about the double digit fall in exports over the last eight months, about the fact that our exchange rate is not really market-determined given RBI intervention, about the fact that in terms of the RBI’s real effective exchange rate index the rupee was overvalued by 25% even before the Chinese move. It almost seems as if our policy-makers believe that the yuan’s exchange rate is more relevant to our exports and imports than the rupee’s!
But to come back to the Chinese move, while the central bank intervenes in the on-shore exchange market to keep the rate within +/- 2% of a reference rate announced daily, the offshore market rate is more market-determined. The Chinese authorities have since announced that any further fall of the yuan is not on the cards and that last week’s changes were in response to the yuan’s exchange rate movements in the offshore market in Hong Kong. Incidentally, a couple of weeks earlier, the IMF had certified the yuan to be fairly valued.
While US politicians have, as expected, criticised the change as “manipulation” of the currency to push up exports at the cost of American jobs, the IMF has, in effect, blessed it as a step towards a more “flexible” exchange rate policy.
In a way, the US criticism of the Chinese move is ironic: “This move by China to allow for more market-determined exchange rates is exactly what the US has been asking for but now the US is turning around and complaining that if China were to allow the market to determine the value of its currency then the currency would become too cheap.” (Eswar Prasad is a CNBC interview, Mint, August 13).
Clearly, market-determined exchange rates are a double-edged sword: they can lead to appreciation or depreciation from fair values, the latter defined as an exchange rate which would keep the current account in rough balance. By that yardstick, the yuan perhaps needs to appreciate from its IMF certified fair value a couple of weeks back. But the IMF’s commitment to the virtues of floating exchange rates remains unchanged: after the first devaluation on Tuesday, August 11, it issued a statement describing the Chinese move as “a welcome step as it should allow market forces to have a greater role in determining the exchange rate”. It added that “China can, and should, aim to achieve an effectively floating exchange-rate system within two to three years”.
The real, if unstated, reason behind the Chinese devaluation could well be to spur slowing economic growth by pushing up exports, which fell 8% in July. The trade remains in surplus but the reserves have fallen over the last two quarters thanks to capital fight by portfolio investors after the sharp fall in equity prices in June/July: this perhaps is the reason why the yuan fell in the market, followed by a corresponding change in the official rate on three successive days last week.
Interestingly, the reactions to the Chinese moves suggest how important the Chinese economy has become to global markets. Some have speculated that the devaluation may delay the interest rate hike in the US as Chinese imports would dampen inflation expectations – and job growth! The yen has fallen 35% since late 2012 (and the euro by 20% since early that year), but neither change has provoked much reaction in the US! Or is it a case of the unexpected having a greater impact than the expected?
