China's move to devaluate its currency yuan has spooked the Indian markets. Though the rupee recovered 14 paise to 64.64 against the US dollar in early trade on Thursday on fresh selling of the American currency by exporters and banks amid positive economic data, concerns over the domestic currency remains.
On the other hand, China set the reference rate for its currency more than one percent lower against the US dollar on Thursday, its third consecutive reduction. The central bank put the yuan's central parity rate at 6.4010 yuan for $1.0, the China Foreign Exchange Trade System said, a drop of 1.11% from the previous day's 6.3306. It all started on Tuesday, when China devalued the yuan by 1.9%.
The move is being viewed as an attempt to counter a falling trend in exports, the frame on which the Dragon’s growth story is built. A weaker currency is intended to make its manufactured products cheaper for other countries to buy, and help its exporters race ahead of competitors in a wobbly world market.
Why should India be worried
The fall in the yuan -- despite a central bank statement that it will keep the currency stable -- implied that more depreciation could be in the offing. This raised dollar demand globally, including in India, weakening the rupee. Exchange rates, after all, are a function of demand and supply.
If the yuan weakens more against the dollar than the rupee does,there is a risk of Chinese goods being dumped in India, or sold at prices below cost of production, or what they fetch in their domestic market.
Imports from China jumped by one-fifth to $60 billion in 2014-15, compared with a year ago, while exports to our neighbour have plunged to $12 billion, leading to a huge trade gap between the two countries.
Dumping or not, the yuan devaluation will tilt the balance further in China’s favour.
Analysts are also worried that China’s move could trigger a string of devaluations by other central banks to help their exporters.
The rupee’s fall reflects anxiety about the negative impact on the Indian economy of the falling yuan. But a falling rupee would lead to problems of its own.
Why a falling rupee is bad
For starters, you may have to pay more at the pump. India imports 80% of its crude oil requirements, and a weaker rupee would mean that our import bill would not fall as much as historically low global oil prices would warrant. This would prompt oil companies to hike petrol and diesel prices. Costlier transport fuel will knock up prices of most goods and stoke inflation.
Higher inflation would mean the central bank will not cut interest rates, ensuring that you fork out large amounts every month to pay your housing loans.
Also expect computers, imported mobile phones and gold to become dearer. A weaker rupee implies you end up paying more to buy dollars for your foreign education. Likewise, if you were planning an overseas vacation, you had better set aside more money. Your air tickets, hotel tariffs, shopping and other costs will all go up.
The slide in the rupee would hit the profits of many companies. Those that borrowed dollars from overseas banks could be the worst hit as repaying loans will become costlier.
Imported raw material such a copper, aluminum and machinery will turn costlier and squeeze profit margins. This may prompt companies to raise prices of consumer goods such as cars and TVs.
If you are an exporter, a weaker rupee would mean your earnings in rupee terms will go up. But a slowdown in the EU, India’s biggest export market, may dry orders up.
What India could do to stem the rupee’s fall
We’re not without options. The Reserve Bank of India could sell dollars in the market to increase the rupee’s value. It has plenty to spare -- India’s foreign exchange reserves are $353 billion. There are several other measures possible that range from floating a sovereign bond to raise money from NRIs to making the import of luxury goods costlier by imposing duties on them.
The next big risk for the rupee
You may have to fasten your seatbelts, or at any rate, tighten your belts. Encouraged by signs of strong economic growth, the US Federal Reserve may raise interest rates, possibly as early as September. This would make investing in the United States more attractive, so foreign, particularly US-based funds, may move money out of India to safer locations closer home.
A dollar flight out of the country, if sudden and copious, can trigger a fall in equity markets and hurt the rupee’s value further.