China got it right, but the world suffered
Investors pull out causing Billions in Losses – India should wait and watch
By TN Ashok
China and India are virtually the fall back economies of the global financial world. While China serves as the manufacturing hub of the world taking care of construction projects with its factories back home, India supports the world with the software needed to run and monitor the projects from its numerous IT companies back home.
Economies in the Euro Zone are struggling to get out of recessionary trends. USA is showing patchy recovery in its economy. They all depend on China and India. And when China devalued its currency, it sent shock waves across the world. The Yuan dipped in value to about 3% to 4% becoming weaker against the dollar. For the US greenback this was relatively modest — but for the UK, which imports and exports a lot to China, the pound sterling lost a huge percentage of its value.
China made a calculated move to devalue its currency as there was no other choice for an economy which had been overheating since the last 18 months. The devaluation was in the offing as a correction but no one saw it coming so swiftly and suddenly , and that’s why no country’s flanks were covered. China’s timing was sudden for the world but not for itself. It sent a whiplash across global economies. Had it come a year ago, when China’s economy was robust, no one would have complained because the impact would have been much less. The Chinese currency devaluation represented the largest Yuan depreciation in 20 years; And its effects are going to be felt thousands of miles away making a big difference to the world.
Lets look at the history for the Chinese currency devaluation. China devalued its currency on August 11 making it a relatively cheaper one than it was before. Stock markets reacted sharply. Particularly in China, Australia, japan, Europe and USA. They all suffered their biggest financial crisis since 2008. India too suffered its massive financial blackout in the stock exchanges when as much Rs seven lakh crore of investors’ money was wiped out in value terms in a single day, making it the biggest stock market crash in India in a decade.
China’s currency devaluation has been building up since the 2009 crisis. Stock markets globally have risen to unprecedented heights in the last six years with the Dow Jones Index clocking its highest industrial average in 2013 and the ascent has been continuous.
The stock market growth was not matched equally by economic growth. USA was showing slow economic recovery while Europe is still struggling, save some like UK and Germany, with a massive debt restructuring plan with Greece at the centre of the crisis. Everyone knew China was slowing down in the last eighteen months which meant that the global stock market rise was actually a bubble which was waiting to be pricked by any event;
the Chinese devaluation was only the key. Actually any other world economic development could have done the same.
China, according to its central bank, The Peoples Bank of China (PBoC) , wanted the exchange rate to be market driven, that is determined by demand and supply. It was hitherto tightly controlled by the federal bank. Demand supply economics made the Yuan cheaper than before. This is exactly what the western world has been demanding for a long time. But they definitely did not want it this time around. The timing was good for China but not for USA and Europe. So when China actually did it, global mayhem followed! The Timing was bad for the world.
Had China devalued its currency last year, global reaction would have been different? Its different now as its negative. Because it comes on the back of a slump in exports and factory output in China, it virtually warned global investors that the Chinese authorities feared a slowdown in their economy and were trying to boost their currency through the devaluation to make their exports more competitive. China is the manufacturing hub of the world and its is now experiencing glut in industrial production because its main buyers in the Euro Zone have been hit hard by debts and have an inability to buy.
China is the supplier to the world at large including India which now faces a daunting trade deficit with the dragon of US$ 48 billion in FY 2014-15 and US$ 8.20 billion in the first quarter of FY 2015-16 ( April to June ). India again owes about US$ 8 billion in crude and petroleum products it bought from Iran but payments were halted because of US sanctions. But India has already put about US$2.9 billion in an escrow account for Iran to withdraw later. The rest needs to be settled. With the US Iran nuclear deal sanctions to be lifted and all countries need to settle their debt with Iran. Besides Iran oil coming in the market will depress oil prices further pushing it to US$ 40 bbl barrier.
China’s economy, the 2nd largest in the world with its GDP at US$ 10.3 trillion and foreign exchange reserves of US$ 5 trillion, if it threatened to slow down, it was the biggest danger signal and bad news for the rest of the world: And this led to sell off in the global stock markets leading to cascading crash in all the exchanges in the world including India when investors pulled out their monies.
How does this affect India?
India has a yawning Current Account Deficit (CAD) , that is the country is not earning enough foreign exchange to pay for its burgeoning imports for crude oil and equipment supplies for its growing services sector covering IT and Telecom. India imports a lot of equipment from China to support its Telecom and IT and IT enables services sector. India is largely dependent on inflows of foreign exchange even by other means. This includes also the so called ‘hot money’ that flows into stock markets, which is right now flowing out.
India’s Textile Imports to Suffer
China’s sudden move to devalue its currency Yuan will have an adverse impact on India’s exports of textiles and clothing, which are facing already sluggish growth due to recessionary conditions in global markets,” Texprocil Chairman K Dalmia said.
Dalmia pointed out that the Chinese government appeared to be more sensitive to the decline in their exports than the Indian government as they had acted with alacrity to arrest the decline in their exports by taking urgent steps like devaluing their currency.
“Our government, on the other hand, regrettably has been unable to appreciate the depth of the decline in our exports and take remedial steps,” Dalmia said. He pointed out that the government has not yet announced the interest rate subvention of 3 per cent, which has been pending despite sanction of funds for this purpose by the Finance Ministry.
India / China – lot at stake following bilateral visits of Modi and Xi Jing Ping
What happens to China affects India and vice versa . So the two economies intertwine. So the Chinese devaluation of the currency means a lot to India and India needs to take the right step that is in unison with the Chinese decision which essentially seeks to protect the Chinese exporters. India needs to protect its exporters as well as also bring down import costs.
Will India also follow the Chinese way and devalue its currency which is already touching the nadir at Rs 65 to a USD. Any further devaluation of the Indian currency could deal a lethal blow to India’s import basket vis a vis the world and vis a vis china because India imports bulk of its telecom equipment and IT industry peripherals from China. India had a trade deficit of US$ 48 billion in FY 2014-15 and an astronomical US$ 8.2 billion in the first quarter of FY 2015-16 April to June.
India’s current account deficit is high because exports are not enough to pay for the imports. Devaluation will help exporters earn more money but not for the country and not large enough to still pay off for the imports. Import costs would be still very high. A tight rope walk for both the commerce and finance ministries to ponder about.
Prime Minister Narendra Modi realised the importance of China and his bilateral visits to the country both ways has been to reduce the trade imbalance. Consider this: PM Narendra Modi made a three-day visit to China to boost economic co-operation. He met Chinese President Xi Jinping in Xian, capital of Mr Xi’s home province of Shaanxi, and later travelled to Beijing and Shanghai. India and China have signed 24 agreements worth over US$10 billion in Beijing after Prime Minister Narendra Modi held talks with Chinese premier Li Keqiang. Business was the main focus of PM Modi’s Chinese foray.
Shortly after Prime Minister Narendra Modi met top Chinese CEOs and addressed a gathering of businessmen, Indian and Chinese companies signed 21 agreements worth about US$22 billion. To Chinese business leaders, PM Modi said, “Now India is ready for business, you would have seen winds of change… I assure you of my personal attention for your success.”
“You are the ‘factory of the world’. Whereas, we are the ‘back office of the world’… Let us work together in mutual interest and for progress and prosperity of our great countries,” the PM said in his speech to executives from 200 Chinese and Indian companies, making a strong pitch for his ‘Make in India’ campaign. This would increase India’s exports substantially to 3rd countries and pay for the burgeoning imports reducing current account deficit. It also revives a stagnating manufacturing sector.
PM Modi invited top Chinese CEOs to ‘Make in India’, pitched the ’5F Formula’ – From Farm to Fibre to Fabric to Fashion to Foreign! PM Modi met CEOs of top Chinese business houses including Xiaomi President Lin Bin, Huawei Chairperson Ms Sun Yafang and Alibaba Chairman Jack Ma in Shanghai and invited them to ‘Make in India’, pitching India’s potential as a manufacturing hub.
The Good Side of Chinese Yuan Devaluation for India
However, there is some good news for India in the Yuan devaluation. China’s economic slowdown means not only stock markets but even global commodity markets are hit due to a fall in the dragon’s demand.
Oil and gold prices are falling along with other commodities such as food and metals, says Dr. Rudra Sensarma, Associate Professor of Economics, Indian Institute of Management – Kozhikode.
Dr Sensarma says as India imports a lot of oil and gold, lower prices are going to help our current account deficit. Lower oil prices will bring down the government’s subsidy to oil companies lowering our fiscal deficit. The money saved can be used for other development needs such as infrastructure spending.
Oil companies such as leading refiners like IOCL, BPCL, HPCL, have all benefited hugely due to decline in oil prices – from US$ 102 last year to US$ 62 and still counting, it may dip to low of US$ 45 a barrel , saving valuable foreign exchange. Only last year oil companies were egging the finance ministry to permit them to issue oil denominated bonds to reduce the burden of subsidies on account of kerosene and LPG. But today they have a surplus of foreign exchange they can recycle to expand their capacities to fuel a burgeoning transport sector. Even explorers such as ONGC and OIL have benefitted.
Lower oil prices will also keep inflation low. Stability on the price front will help companies to make investments leading to job creation. Lower inflation will help the RBI Governor Dr Raghuram Rajan to keep interest rates low to further propel growth, a decision he has been withholding by not tinkering with the Repo rates ( rates at which RBI lends to commercial banks) or lending rates so as to keep inflation under check and money supply under a tight leash.
Finance Minister Arun Jaitley has been upholding the cause of the industry asking the RBI to lower interest rates to propel growth in the manufacturing sector that is virtually stagnating now. Only the services sector such as IT and Telecom has kept India’s economy buoyant.
The Chinese devaluation could also play with the Indian rupee. The rupee is losing value as investors pull out their funds from the country – its has sunk to record levels of Rs 65 to a US dollar. This will help our exports to remain competitive and withstand the pressure from China’s now cheaper exports.
What is India’s action plan?
As foreign investors pull out of BSE or NSE in search of better markets, it’s critical for the BJP led NDA government to encourage more Foreign Direct Investment (FDI), including foreign companies interested in setting up businesses in India. This is the time for the government to come out with more imaginative liberalised economic policies to attract more foreign investment through the FDI route because no one can prevent portfolio investors from exiting the Indian markets.
Government should speed up such reform legislations that do not require Rajya Sabha approval because the BJP does not have the required strength there. The centre can empower state governments to frame their own laws in the spirit of competitive federalism. The government can fast track clearances for mega foreign investment projects especially in infrastructure sectors such as power and oil and gas.
The impact of China’s currency devaluation on India’s economy could also be turned into an opportunity to sell of stakes of loss making public sector companies that are bleeding the exchequer.
Government can come out with schemes to encourage NRIs and PIOs to invest more in India. Finally the government should have absolute clarity on taxation issues and not upset the already nervous foreign investors.
What the Chinese currency devaluation has shown is that countries can no longer live in isolation but are more closely linked to each other than before. This is the time for greater international cooperation in economic policies. Central banks cannot provide long term solutions to global economic challenges. China has realised it the hard way.
It wanted to break free from PBoC control and allowed the Yuan to float freely in the international market, but the move back fired, because of its economic slowdown, exports slump, inventory pileup. The game was to strengthen the Yuan as an international currency bracketing it with the US dollar and the Euro with the IMF to be entitled to Special Drawing Rights(SDRs). SDRs facility would have allowed China to float Yuan Denominated Bonds in the international market helping it to mop up huge monies in US dollar and Euro terms. But this did not happen. The Yuan fell flat after its free float in the international currency market with no back up from PBoC. China’s strategy was right, but the timing was wrong.