CHINA, the second largest economy of the world, brought a shock to world markets last week. The Chinese currency Renminbi (Yuan) lost its value against the US dollar by nearly 3% between 11-13 August. Over two decades this was the sharpest weekly fall in Yuan.
What has actually happened to Chinese Economy?
Chinese stocks surged highly, more than doubling in 12 months. Stocks rose even as the Chinese economy was slowing. The foreigners and domestic institutions bought shares in large companies which had stable business. The working class and middle class families invested in inexpensive shares in small and medium sized companies, and kept buying shares even by borrowing money simply because they were rising. The negative sides of the companies like weak balance sheets and improper corporate governance were ignored. As investors realized that market was getting overheated, the Chinese stocks had brief periods of weakness in recent months. The government kept on regularly reassuring investors, helping to steady the markets. Now, investors started losing faith. After a drop of more than 7% in Shanghai and Shenzhen markets on June 26, the Chinese Central Bank responded the next day with an interest rate cut. But a broad slide in stocks continued, so the government had to take a more concrete step. On July 9, stocks rose even after so many government measures to control market. But on July 27, the main Shanghai share index plunged 8.5%, its steepest one day drop in eight years, casting new doubt on the government’s measures to support share prices. This erased all the gains it had made in its extraordinary run up this year. In August, China abruptly devalued its currency, and authorities said market forces would play a bigger role in determining the value of Yuan.
What were the reasons for this devaluation?
When this question came on the table, People’s Bank of China, China’s central bank, soon stepped in to clarify:
It said that devaluation marked the transition to a flexible, more market based system of determining China’s exchange rates from the system that existed until now in which the value of Chinese currency had largely been fixed by the government. If PBOC’s claims are true, it is likely to be a component of a larger, national strategy to internationalize Yuan. China wants to see Yuan emerge as a currency for international trade and finance, like the dollar. It also plans to build Shanghai into a global financial centre. China is trying to get Yuan included in the basket of currencies in IMF’s Special Drawing Rights.
What impact did this devaluation of Yuan has on the Global Economy?
China is the biggest importer of commodities, from countries like Australia and Brazil. China is also a huge buyer of factory equipment and other machinery in Germany and other places. Now as the Chinese stock market changes damage the consumer confidence, it would slowdown in these purchases. With the devaluation of Yuan, imports from China will increase, worsening the domestic industries of India.
One interpretation of this devaluation was an attempt by the Chinese authorities to boost export demand for its manufactured goods. Some argue that the Chinese action might trigger a new global currency war- where other countries too devalue their currencies to compete with China in trade. And this devaluation in Yuan actually will change the destiny of companies of China which largely depend on imported goods.Thus this brings into light the phenomena that one change in any economy is bound to impact the entire global economy.