During the week, the People’s Bank of China (PBOC) did something that global markets were apprehending for a long time. It let the Yuan slip below the CNY7/$ mark and that led to a near panic situation among most emerging markets, including India. For China, it was a logical response to the US move to raise tariffs by 10% on goods worth $300 billion. First, what exactly is this trade war implication?
Trade war triggers Yuan fall
The PBOC, which is the Chinese central bank, normally keeps the Yuan in a range. The sharp correction in the Yuan was last seen in 2015, when it had impacted all the EM currencies. The fall in the Yuan was much sharper this time around, going beyond the CNY7/$ for the first time in the last 10 years. The surprising part was that the Yuan did not stop and inched closer to the 7.1 mark. However, better trade surplus data from China and US threats of classifying China as a Currency Manipulator led to the Yuan gaining some strengthening towards the latter half of the weak. Trump tariffs would clearly mean that Chinese products get more expensive in the US. This makes Chinese products less competitive. The only way to arrest the slowdown that it was causing in China was to let the Chinese Yuan weaken. This would compensate for the higher costs and ensure that the Chinese exports engine did not suffer in a really big way.
Why Yuan is the worry
A weak Yuan is a worry for two reasons. Firstly, if China gets declared as a currency manipulator, then it could really roil the global currency market because the Yuan is now part of the IMF basket too. That is a situation which most countries would want to avoid. China also has a trump card in hand in the form of its $1.3 trillion in US dollar treasury holdings, which it could use as a bargaining chip to create chaos in the global currency markets. Secondly, for countries like India, the immediate problem is a weakness in the INR. Since the CNY problem began, we have seen the INR fall from 69/$ to nearly 71/$. That has serious repercussions for FPI flows, which has anyways been on a downswing since the Budget. The CNY devaluation could only make it worse.
Currency war concerns
The real worry for the world economy is that it could trigger a vicious currency war. The world has not seen a currency war in the last 100 years and such Chinese action could just about trigger a major currency war. In a currency war, each nation tries to boost exports by lowering the value of its currency. The only big risk in any currency war is that there are no winners. Currency wars typically lead to a weaker currency, lower output and major contraction in the economy. That is something that is best avoided at this point in time! ©
