COMMENTARY

Yuan Devaluation and

Its Impact
Biswajit Dhar

The warning signals have been

there for some timeChinas
merchandise trade has been
contracting and its economy has
been slowing. Now the yuan has
been devalued by 1.9%. What
will be the outcome, especially
for India?

he fragile foundations of the global

economy have been shaken again
by the recent devaluation of the
Chinese yuan by 1.9% against the dollar.
The Chinese authorities allowed the
redback to depreciate not once, but
thrice in quick succession, an occurrence
that was received with a sense of shock
the world over. This reaction was another
grim reminder of the fact that national
authorities and the global institutions like
the International Monetary Fund (IMF)
continue to suffer from their inability to
anticipate crisis situations such as the one
that has been triggered by the devaluation
of the yuan. This appears rather unusual
for over the past year the Chinese economy
had given enough signals that it was
losing momentum, which could have adverse implications for its currency.
Slowdown of Chinas Economy

Biswajit Dhar (bisjit@gmail.com) teaches at

the Centre for Economic Studies and Planning,
Jawaharlal Nehru University, New Delhi.
Economic & Political Weekly

EPW

SEPTEMBER 5, 2015

Since the beginning of 2014, there were

clear signs that the Chinese economy
was slowing down, a development that
President Xi Jinping wanted the world to
accept as the new normal of Chinas
economy (Xinhua 2014). Until the first
half of 2011, the Chinese economy grew
close to the old normal rate of close to
10%, but by the fourth quarter of 2014,
the growth rate fell to just over 7%. There
was more disappointing news in the first
quarter of 2015; Chinas gross domestic
product (GDP) growth dipped below 7%,
the first time since the early 2009 when
the Chinese economy was rocked by the
global economic downturn. Although in
vol l no 36

the second quarter, growth rate was back

to 7%, the IMF has estimated that the
Chinese economy would grow by 6.8%
in 2015 (IMF Survey 2015). Should this
prediction be true, it would be the first
time a sub 7% growth would be recorded
for a full year since 1991.
Chinas GDP growth has been severely
dented by the slowing down of its
merchandise trade. Since 2012, Chinas
merchandise trade has been on a decelerating growth path; in 2014, the growth
was down to just 3.4%. During the year,
imports barely grew, while exports grew
by only 6%. But very few among the
policymakers both in China and elsewhere, would have been prepared for
what has been happening on the trade
front in 2015. For the first time in its
post-reform phase, Chinas trade sector
is heading for a negative growth in a
normal year. In the first seven months
of the current year, Chinas imports have
declined by over 7.5% and its exports are
down by nearly 4%, as compared to the
corresponding period in the previous
year. These numbers were possibly the
clearest signals that Chinas economic
woes had reached the tipping point.
These perceived signs of economic uncertainty were fanned by the negative
sentiments emanating from the capital
market. Over the past two years, China
has been witnessing outflows of capital,
which, according to market analysts have
grown rapidly in recent months. The estimates of capital outflows from China
vary widely, which makes it difficult to
assess the magnitude of the problems
that the country is facing on this front.
The worrying sign for China is that it is
facing an acute crisis of perception arising from the negative sentiments of the
fund managers. According to JP Morgan,
in the past four quarters, capital outflows from China were in the range of
15

COMMENTARY

$450 billion (Bloomberg Business 2015),

after adjusting for changes in the valuation of foreign exchange reserves. The
Telegraph has reported two assessments
by fund managers, which point to the
broad magnitudes of the outflows. Charles
Dumas of Lombard Street Research has
made an assessment that capital outflows
from China had reached $800 billion over
the past year, while Robin Brooks of
Goldman Sachs estimated that the second
quarter of 2015 alone had seen outflows
exceeding $200 billion (International
Business Times 2015). However, the
veracity of these numbers remains
doubtfulsimilar estimates provided for
the third and the fourth quarters of 2014
were found to be considerably larger
than the official statistics provided by
Chinas State Administration of Foreign
Exchange. Thus, while there are no two
opinions that the Chinese economy is
experiencing capital outflows like never
before, the precise magnitude of these
outflows remains debatable.
Pressure of Appreciation
Putting further pressure on the Chinese
authorities was the upward push faced
by the yuan following the appreciation
of the dollar. Although the yuans formal
peg to the greenback was removed a
decade back, there is nonetheless a tacit
link. The yuan has been pegged to the
dollar via a daily reference rate set by
the Peoples Bank of China and is allowed to fluctuate within a fixed band,
set at 1% on either side of the reference
rate. The steep appreciation of the dollar
in the recent past was rubbing-off on
the yuan and an appreciated yuan was
eroding the competiveness of Chinese
exports. The value of its currency played
a significant part when China was pushing its products in the international
market and interestingly, the same factor had once again raised its head in
making its products uncompetitive.
In recent months, the fact that yuan
was overvalued has been accepted even
by the IMF. In its report following the
recent Article IV Consultation with China,
the IMF (2015a) has reported that the
REER (real effective exchange rate) has
been on an appreciating trend since the
2005 exchange rate reform, gaining an
16

average of 5% a year during 200614 (3%

in 2014). According to the IMF, in all the
yuan has appreciated... 55 percent since
the exchange rate reform in 2005. And
Over the past year, the REER has appreciated by over 13 percent (April, year-onyear), in tandem with the rise in the US
dollar. By May 2015, the REER appreciated
by 11 percent against the 2014 average...
(IMF 2015b: 73).
With the yuan now adjusting to lower
levels, Chinas sagging exports could receive a much needed prop. There could be
two more advantages for China, both of
which are intrinsically linked. The first of
these is that China now has the opportunity to silence its critics, especially from
the US, that it does not allow its currency
to respond to market forces. The US has
been leading the charge that the yuan was
artificially undervalued and had compelled the Chinese authorities to intervene
to keep the currency overvalued through
the managed float arrangements (some
call it the dirty float).1 This should now
be pass given the weight of evidence in
favour of yuan depreciation.
The second and more important advantage that China could cash in on, as a result
of making its currency respond to market
forces, is that the yuan could be on its
way to be included in the basket of currencies used to determine the value of the
special drawing rights (SDR). The yuan
has been on the threshold of being
included in the basket, but was found
wanting on one of the two criteria used
for including any currency in the basket.
IMF (2015c) considers a currency for
inclusion in the basket
whose exports of goods and services had
the largest value over a five-year period,
and have been determined by the IMF to be
freely usable. In the previous review of the
basket undertaken in 2010, the yuan was
not considered because it was seen as not
fulfilling the latter criteria. Now that its currency is on its way to becoming more market
determined, China would have a strong case
for its inclusion in the SDR basket and be
recognised as a reserve currency.

Implications for India

What could be the likely implications of
yuan devaluation for India? The first
and the most obvious is the impact on
Indias bulging trade imbalance with its

largest trading partner. Over the past

decade, the trade imbalance in India
China trade has increased by 33-fold. In
200405, Indias adverse balance vis--vis
China was less than $1.4 billion, a figure
that had swelled to nearly $48.5 billion.
This spectacular increase in trade deficit
was fuelled by a steep increase in Indias
import bill with China, from less than
$11 billion in 200405 to over $60 billion in 201415, and, on the other, by
almost crawling export earnings; the
latter increasing from $5.6 billion in
200405 to less than $12 billion in
201415. It needs to be pointed out that
while Indias imports from China have
steadily increased (barring the year in
which the global economic downturn
was making its impact felt), its exports
to China peaked in 201112 at $18 billion, before falling below $12 billion
in 201415.
Table 1: IndiaChina Merchandise Trade ($ billion)
Years

Export

Import

200405
200506
200607
200708
200809
200910
201011
201112
201213
201314
201415

5.6
6.8
8.3
10.9
9.4
11.6
15.5
18.1
13.5
14.8
11.9

7.1
10.9
17.5
27.1
32.5
30.8
43.5
57.5
52.2
51.0
60.4

Trade Balance

-1.5
-4.1
-9.2
-16.3
-23.1
-19.2
-28.0
-39.4
-38.7
-36.2
-48.5

Source: ExportImport Data Bank, Department of Commerce.

Importantly, Indias inability to penetrate Chinas markets occurred even when

the trade-weighted rate of the Chinese
currency was appreciating vis--vis a
basket of 43 currencies.2 These figures
show that the rate of appreciation of the
yuan was lower in the pre-2008 crisis,
but it increased sharply after the crisis
when China had to allow appreciation of
its currency under pressure from the US,
a point we had made earlier. However,
even during a phase of appreciation of
the yuan, Indias imports from China experienced a steep increase and exports
witnessed a slump.
The composition of IndiaChina trade
in terms of the broad product groups
provides yet another facet to understand the likely impact of yuan devaluation on India. Tables 2 and 3 (p 17) provide the data on commodity composition

SEPTEMBER 5, 2015

vol l no 36

EPW

Economic & Political Weekly

COMMENTARY

of India exports to and imports from

China over the past decade.
The tables show that while the composition of Indias exports to China has
changed considerably, the composition of
its imports from China have remained
fairly stable. Over the past decade, India
has graduated from being a supplier of
raw materials and intermediates to China.
Consumer and capital goods, which made
up for just 5% of total exports in 2005
had increased to more than a fourth of
Indias exports in 2014. At the same
time, the share of raw materials in Indias
total exports to China decreased from
nearly 70% in 2007 to less than 24% in
2014. An interesting development has
been that the share of intermediate goods
in total exports had exceeded 50% in
2014. This number could be seen as a
measure of participation of manufacturing units based in India in the production
networks that Chinese entities are involved
in. Thus, while absolute levels of Indias
exports to China have looked increasingly
dismal, especially over the past few years,
the commodity composition of Indias exports has shown a distinct improvement,
with value-added product groups increasing their shares. Yuan devaluation, therefore, imposes an additional burden on
the fledgling manufacturing sector to
find ways of maintaining this favourable
trend in commodity composition.
Indias imports from China are largely
capital and intermediate goods (nearly
82% of the total in 2014). Yuan devaluation
would therefore have a favourable impact
on the projects that are relying on supplies
from China and may, in course of time,

encourage new projects to import from the

same source. Similarly, use of intermediates imported from China would provide
an additional price advantage to Indian
manufactures, particularly in the competitive global markets. But with manufacturing imports from China becoming
attractive, domestic manufacturers would
face a further squeeze on their bottom
lines. India Inc has already been making
demands for increasing tariff protection to
protect its interests from Chinese imports
(Economic Times 2014), and such demands
are likely to increase in the ensuing days.
Among the specific industry groups,
which could face serious competition in
the international markets arising from
the devaluation of the yuan, an important one is textiles and clothing. This
group has the largest share of Indias exports among manufacturing industries
(12% in 201415). Further, its share has
increased over the past few years. In the
global markets, Indias textiles and
clothing have had to compete with,
among others, the market leader, China.
Interestingly, Indias share in the global
market for textiles has been rising
steadily over the past decade, while
its share in the market for clothing
has remained stagnant (Table 4). This
industry, which is also one of the largest
employers in manufacturing, would need
Table 4: Indias Share in Global Textiles and
Clothing Markets
(in %)
Years

Indias Share in Global

Exports of Clothing

Indias Share in Global

Exports of Textiles

2000
2005
2010
2013

3.0
3.9
5.1
6.2

3.6
3.9
3.2
3.7

Table 2: Composition of Indias Exports from China

Product Groups

Capital goods
Consumer goods
Intermediate goods
Raw materials
Unclassified
Total Exports

(% distribution)

2005

2006

2007

2008

2009

2010

2011

2012

2.5
2.6
32.3
62.3
0.3
100.0

3.6
3.1
26.8
66.3
0.3
100.0

3.3
3.5
20.2
69.8
3.2
100.0

3.3
3.5
20.2
69.8
3.2
100.0

6.4
6.0
32.0
54.6
0.9
100.0

3.2
3.9
41.8
50.9
0.2
100.0

4.9
10.8
36.1
47.6
0.5
100.0

5.3
5.7
44.9
43.7
0.4
100.0

Table 3: Composition of Indias Imports from China

Product Groups

Capital goods
Consumer goods
Intermediate goods
Raw materials
Unclassified
Total imports

2006

2007

2008

2009

2010

2011

2012

41.8
11.3
39.5
6.5
0.9
100.0

42.9
10.6
39.1
4.5
2.9
100.0

42.5
12.7
40.9
2.1
1.8
100.0

37.5
11.3
38.0
2.1
11.2
100.0

51.0
13.2
28.1
1.6
6.1
100.0

46.3
11.4
32.5
1.6
8.1
100.0

43.2
12.1
33.3
2.8
8.6
100.0

43.6
12.7
32.5
2.4
8.8
100.0

Sources for Tables 2and3: UN COMTRADE Database.

EPW

SEPTEMBER 5, 2015

2014

7.4 10.2
7.2 15.3
48.8 50.5
36.2 23.7
0.4
0.3
100.0 100.0

(% distribution)

2005

Economic & Political Weekly

2013

vol l no 36

2013

2014

46.5 45.1
14.1 13.7
32.9 36.7
1.1
1.0
5.4
3.4
100.0 100.0

to be supported by the government to face

the challenge posed by yuan devaluation.
There is therefore little doubt that the
devaluation of the yuan would adversely
affect the interests of Indias manufacturing sector, a scenario that does not bode
well for the Make in India project. In this
context it should be pointed out that the
real impact of yuan devaluation could be
felt through another development. Currently, India is engaged in the shaping of
the Regional Comprehensive Economic
Partnership (RCEP), a mega-regional free
trade agreement in which 15 countries in
the East Asian region, including China, are
participating. The nature of tariff cuts that
India would offer to China while signing
on to the RCEP would also have a role to
play in determining the extent of market
penetration that products from Asias
largest economy would eventually make.
notes
1

In the 111th Congress (January 2009 to January

2011), four bills were introduced that included
provisions stating that currency misalignment
be used as a factor for the purposes of US antidumping investigations and the calculation of
anti-dumping duties for imported products determined to be sold at less than fair market value
and injure a US industry. Two of these bills also
included provisions wherein currency misalignment could have been used as a factor in US
countervailing investigations (involving government subsidies) and the calculation of countervailing duties for imported products determined
to injure a US Industry. For details see, Morrison,
Wayne M and Marc Labonte (2013), p 9.
Based on the broad indices provided by the
Bank for International Settlements.

References
Bloomberg Business (2015): Why Capital Outflows
From China May Be No Cause for Alarm, 1 August.
Economic Times (2014): India Inc Seeks Curbs on
Chinese Imports, Cheaper Capital, Tweak in
Duty Structure, 30 December.
International Business Times (2015): China Downplays Capital Outflow as Foreign Investment
Banks Raise Concerns over Economy, 24 July.
IMF Survey (2015): Chinas Transition to Slower
But Better Growth, 14 August.
IMF (2015a): 2015 External Sector ReportIndividual Economy Assessments 26 July, p 13.
(2015b): 2015 Article IV ConsultationPress
Release; Staff Report; and Statement by the Executive Director for the Peoples Republic of
China, 14 August available at: http://www.
imf.org/external/pubs/ft/scr/2015/cr15234.pdf.
(2015c): Factsheet on Review of the Special
Drawing Rights (SDR) Currency Basket, 5 August, available at: http://www.imf.org/external/np/exr/facts/sdrcb.htm.
Morrison, Wayne M and Marc Labonte (2013): Chinas
Currency: An Analysis of the Economic Issues,
Congressional Research Service, Rs 21625.
Telegraph (2015): Capital Exodus from China
Reaches $800bn as Crisis Deepens, 22 July.
Xinhua (2014): Xis New Normal Theory,
9 November.

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