The persistent economic growth slowdown and China’s aim to become a global leader have prompted it to take the revolutionary decision to devalue its currency. It is reported that China could be willing to let the yuan depreciate gradually by as much as 25% over the next five years. Indian economy can reap benefits in the long run as import costs and commodity prices fall but sectors like textiles, steel, metals and tyres may suffer.

The world is passing through some very challenging trends. Nervousness gripped Indian markets with worsening global growth outlook accentuated by the Yuan devaluation that has led to fears of contagion and also recessionary fears. The depreciating rupee has spooked investor sentiment, pushing stocks downwards sharply.

The yuan depreciated 2.9% after the People’s Bank of China announced its move on 11th August 2015 toward a more market-determined rate. Chinese persistent economic slowdown and the Chinese currency peg against the dollar becoming increasingly costly might have been immediate triggers to the decision. The Rupee has lost over 2% since the Yuan devaluation on 11th August 2015, dipping to a two-year low at 65.34 (17th August 2015) and remains biased towards further falls.

The biggest hit parties in the wake of this unexpected move by Beijing to weaken the yuan are likely to be the commodities sector, exporters to China and those economies that are in direct competition with China. This decision to devalue could bring a fresh wave of price weakness to the global economy. Fear of a deflationary wave has also got strengthened. India is sure to get impacted, which implies that India will have to make deft structural moves fast to enhance its competitiveness. In fact, with the China’s strategic move, the entire global financial structure will start moving on a transformational phase, wherein Indian expertise could play a major role.

Chinese moves being unpredictable could prove a bigger source of risk to financial markets than the persisting international concerns like the Greece debt crisis or a hike in US interest rates. The chaos in China seems to be far worse than what is obvious. Chinese moves are likely to keep evolving and will continue to give shocks.

According to Dr Subir Gokurn, former DG-RBI “In the short term, labour intensive sectors like textiles, manufacturing and small producers will get affected as exports slow down... Long-term macro economic impacts however are still not visible”.

Recent Developments in China: Falling Chinese equities, the Yuan’s sudden chain of devaluation, a sharp decline in exports and the subdued factory output – all suggest that China is confronting a painful transition towards a new economic model that is shifting base from export orientation to domestic consumer demand. The key question is how it will affect the Indian economy and its exports in the coming months. Still bigger source of worry is the competitive devaluation that has started taking place among the affected countries. Indian authorities seem to be on the right path of concentrating on making the domestic economy strong. The RBI is likely to take major strategic action in case the Yuan gets further devalued.

With $60.4 billion of exports to India in FY15, China accounts for around 13% of India’s total imports. Indian economy has a trade deficit of $48 billion and China has been demanding more market access to Indian products. Some finance ministry officials have even called for the lowering of interest rates, as well as allowing the rupee to depreciate to remain competitive and to boost investments in the country.

Against The Above Backdrop The Key Areas Of Concern Are:

i. In general, the main worry is on the global account. Sensex has erased gains of 2015 on global growth concerns and weak rupee.

ii. Any slip on the part of Indian authorities in policy making showing retreat from risk could create selling pressure on Indian assets.

iii. A depreciating rupee may raise financial stress for companies that have not heeded to the RBI Governor’s advice of hedging their dollar liabilities.

iv. Another worry is the extent to which Chinese economy will slow down. Will it be to a level of 5-6% or 3-4%.

v. Exports continuing to fall especially with the devaluation of the Yuan spelling trouble for export oriented industries.

vi. Persistent non-performing asset (NPA) concerns accentuated by China slowdown and Yuan devaluation.

A depreciating rupee may raise financial stress for companies that have not heeded to the RBI Governor’s advice of hedging their dollar liabilities

On The Other Hand, The Pluses Are:

1. Most significant upside of a devalued Yuan would be lower import bills.

2. Decline in global commodity prices akin to a tax cut will boost real incomes of people. These will also reduce input costs of the economy. Prices of a plethora of major imports such as metals, chemicals, rubber, petroleum products, electrical and electronic components are likely to drop further 5 to 15 % over the next few months.

3. India likely to witness by the end of the fiscal year a current account surplus despite weak exports.

4. There will be fiscal benefit too. Oil prices have slid considerably to a six-year low to below $42 a barrel as a consequence of slackening demand from China. It is said that every dollar drop in oil price saves a billion dollars off the country’s import bill. This means the country has already started saving a big chunk on crude imports.

5. Industries like information technology, pharmaceuticals, auto ancillary and chemicals that earn a higher share of their revenue from exports rather than domestic markets, are also pinning their hopes on a weakening rupee in the wake of the Yuan devaluation.

6. Amidst scenario of competitive devaluation the Indian economy is relatively on top among emerging markets in terms of both, strength of currency and stock market performance. As such the Indian economy enjoys unique opportunity of increasingly becoming the only attractive investment destination amongst emerging markets.

7. Government policies have been proactive like recent measures to tackle NPAs; disinvestments taking place early in the year; improving revenue position despite increasing government expenditure amongst many others. Department of Revenue of the Ministry of finance had a two-pronged objective in the past one year – to create an enabling business environment to encourage investment and growth, and to create a robust and strong financial law enforcement framework.

8. The Make in India initiative has started giving some encouraging results though there is a long way to traverse.

In IMF view, it is ‘premature’ to speak of the Chinese crisis. China’s economic slowdown and a sharp fall in its stock market herald not a crisis but a “necessary” adjustment for the world’s second biggest economy

Some Comments:

• Investors may still underestimate how much the world’s second-largest economy would slow.
• Yuan’s Devaluation though a concern for some companies should be viewed more as an opportunity for India. It has been reported that beneficial results will be seen in about three months time.
• Stress in the steel sector has resulted in the creation of NPAs for banks, which has compromised banks’ ability to lend to other sectors. Steel sector is the largest contributor to the NPAs of the banks. Gross NPAs of the public sector banks (PSB) rose to Rs 2.67 lakh crore at the end of March quarter. Assuring support to the sector, the finance minister has said, “The root cause is that you have to take into account various factors and make our own domestic industry competitive, and when you become competitive, the external factors ability to adversely affect you is also reduced... .. hand-holding can take place up to a point.” Referring to the capacity building he stated, “Sooner or later our mining capacity (has to be)... expanded so that the availability of excessive raw material itself will ensure that market forces bring down the raw material prices.” The crucial aspect is that the government has to create that enabling and friendly environment in which there is no adversity.
• Infrastructure projects both from the central and state governments needs to kick-start growth in the sector. Though prices have been falling over the past six to eight months now, the domestic market is not sustainable as state and central governments are not participating in and spending more on infrastructure. Even banks have to be shell out more loans to provide a boost to the construction activity.
• Most importantly, it has become imperative for all stakeholders to tackle negative growth in Indian exports. The export strategy needs to be innovatively structured coupled with strengthening of domestic production through Make-in-India
• It is important to note is that on any risk emerging like the current persistent slowing of the Chinese economy, Chinese leaders would be attaching importance to both political stability as well as economic innovation. In other words, on the one hand of the economic issues, China wants to become a global market economy but on political and security issues it will be imposing more controls.
• More deep research on the sudden Chinese devaluation of Yuan and its impact on the global economy as well as the Indian economy is called for. The decision to devalue the yuan which has sparked competitive devaluation by many countries underscores serious worries over China’s economic slowdown and its global implications, particularly for industries and companies. All Indian stakeholders –government, financial institutions and companies would be coming across varied economic opportunities, which should be grabbed at slightest inkling.
• In international monetary fund (IMF) view, it is ‘premature’ to speak of the Chinese crisis. China’s economic slowdown and a sharp fall in its stock market herald not a crisis but a “necessary” adjustment for the world’s second biggest economy. Monetary policies have been very expansive in recent years and an adjustment is called for.
• It is likely that the China’s resistance to reform may grow with the IMF rebuff to Yuan’s inclusion in the IMF’s special drawing rights. Given their recent policies that favor stability over reform, China’s leaders have come to view the Yuan as a reserve currency to get delayed.

Summing up can be best done by quoting the finance minister’s opinion that “I have no doubt that our ability to withstand the transient global trend, created predominately by external factors is very strong.” This is strengthened by the Railway Minister, “At the pace at which India’s GDP is growing, India can double the same over the next three- to-threeand-a half years propelled by the efforts being made by the government....To reach one trillion (USD) GDP mark, it took India 20 years, but it added the next trillion in just seven years. Today the Indian economy can double its size in the next three to-three-and-a-half years.” Macroeconomic indicators like inflation, forex reserve, capital investment in infrastructure and revenue collection have been turning positive.

Written By:  Kiran Nanda