China’s decision to devalue its national currency, the China yuan renminbi or yuan for short, in August 2015 took the global financial markets by surprise. By engineering a 4% drop in the yuan over two days, the People’s Bank of China (PBOC) sent most other currencies reeling, including the Indian rupee, which sank to a two-year low against the U.S. dollar.
Why China Devalued the Yuan
China’s decision to devalue its currency for the first time in more than two decades came in response to a slowing domestic economy. China’s gross domestic product (GDP) expanded 7.3% in 2014, the slowest rate in 24 years. Growth is expected to slow again in 2015 and remain below the 7% mark for the foreseeable future as Beijing attempts to restructure the Chinese economy away from export dependence and toward consumption. The currency devaluation was one of many monetary policy tools the PBOC employed in 2015, including interest rate cuts and tighter financial market regulation.
Although the PBOC described the yuan devaluation as a “one-off depreciation” after a series of poor economic data, the decision sparked fears about a global currency war between China and the West. For India, a weaker Chinese currency has several implications.
Rupee Volatility
China’s decision to let the yuan fall against the dollar raised the specter of more depreciation in the near future. As a result, demand for the U.S. dollar surged around the globe, including in India, where investors bought into the safety of the greenback at the expense of the rupee. The Indian currency immediately plunged to a two-year low against the dollar and remained low throughout the latter half of 2015. The dollar-to-rupee exchange rate referenced by the global currency markets has strengthened more than 5% since mid-August. The threat of greater emerging market risk-off as a result of the yuan devaluation led to increased volatility in Indian bond markets, which triggered additional weakness for the rupee.
Declining Exports
India’s export sector has been hit hard in 2015 by the global economic slowdown. The slowdown in China, which is among the top-five destinations for Indian products, is also weighing on Indian exporters. Normally a declining rupee would aid domestic manufacturers by making their products more affordable for international buyers. However, in the context of a weaker yuan and slowing demand in China, a more competitive rupee is unlikely to offset weaker demand. Additionally, China and India compete in a number of industries, including textiles, apparels, chemicals and metals. A weaker yuan means more competition and lower margins for Indian exporters; it also means Chinese producers will be able to dump goods into the Indian market, thereby undercutting domestic manufacturers. India has already seen its trade deficit with China nearly double between 2008-2009 and 2014-2015.
Lower Commodity Prices
As the world’s largest energy consumer, China plays a significant role in how global crude is priced. Slowing Chinese demand has been a principal factor behind the oil price collapse that began in June 2014, and the PBOC’s decision to devalue the yuan signaled to investors that Chinese demand would continue to crumble. In fact, global benchmark Brent crude has declined more than 20% since China devalued its currency in mid-August. For India, every $1 drop in oil prices results in a $1 billion decline in the country’s oil import bill, which stood at $139 billion in fiscal year 2015.
On the flip side, falling commodity prices are making it much more difficult for Indian producers to remain competitive, especially highly leveraged companies operating in the steel, mining and chemical industries. In addition, it is reasonable to expect the yuan depreciation will lead to further weakness in the price of other commodities that India imports from China, making it all the more difficult for India to remain competitive both domestically and internationally.
