Chinese currency jolt to India

China devalued its currency Yuan by 1.9% on last Tuesday. It fell by another 1.6% on Wednesday. Thus, in two days, Yuan got 3.5% cheaper than US dollar. One can't be sure that there won't be any further depreciation of Chinese currency. Many expect that it may go down to 7 yuan for a dollar from the current level of 6.41 yuan to a dollar. Most analysts agree that Yuan devaluation was forced by internal compulsions such as lower than expected retails sales and industrial output. #YuanDevaluation#

Besides, Yuan has appreciated against almost every other currency in the last 18 months: it's still up 20% against the Euro, 15% against Japanese Yen and 10% against South Korean Won that was putting pressure on its exports. Chinese merchandise exports fell by over 8.3% in July (YoY) over previous year. More worrying for China is its exports to the EU and the US which posted a decline of 12.3% and 1.4% respectively.  Not only this, China witnessed a drop of 5.4% in its factory gate (wholesale prices) prices in July and needed help.

Some claim that it was prompted by IMF's decision to postpone including Yuan in the basket of reserve currencies which required Chinese currencies to move towards greater exchange rate flexibility.

Whatever may be the reason behind Chinese move, it has sent tremors in Indian stock markets, and many fear that it's the start of #currency war# as devaluation leads to competitive devaluation. While considering this as a trigger for currency war would be a bit of exaggeration, there's not doubt that a weakened Yuan has serious implications for India's trade balance, and fortunes of Indian companies having exposure to China.  

Depreciation of Yuan saw India's stock and commodity markets crashing. The Sensex fell 358.83 points to 27512 and the Nifty shed 112.9 points.  The top losers were commodity players, Vedanta and Hindalco, and Auto major Tata Motors which have serious Chinese exposure.   

Given the trade linkage of China and ASEAN nations as well commodity exporting nations such as Australia, Russia and South Africa, their currencies fell too in response to Yuan slide. Since, Indian Rupee is also pegged to US dollar, Yuan depreciation has implications for India's exports and imports as well as for many India companies. 

1. India and China compete in many export markets, the EU and the US in particular to sell man-made fibres, apparels, steel, gems and jewellery and organic chemicals. Since, Rupee has lost only about 3.48% vis-a-vis US dollar since YTD, Yuan slide will worsen India's export competitiveness in these items  vis-a-vis their Chinese counterparts. As a result, India's merchandise exports may have to take a beating unless RBI lets Rupee depreciate to match fall in the #Chinese currency#. 

2. Because of weakened Chinese currency, #India's exports# of cotton yarn, copper, organic chemicals, mineral fuels, salt, cement, plastics and mechanical appliances to China will become expensive. Obviously, companies exporting this items to China will soon feel pressure on their revenues and profits.

3. Not only that, Indian businesses should be ready for more Chinese exports of steel, power equipment, fabrics and apparels, chemicals, fertilizers and tyres being dumped to India. That in turn will further increase India's trade deficit with China which was already very high at  US $ 48.4 billion in FY 2014-15. It would also mean a further squeeze on the domestic sales and operating margins of businesses selling the above products, steel and tyre companies in particular. India's steel import  is already up by 71%. Faced with excess capacity, global steel glut and increasing imports from China, Japan , Korea and Russia, steel companies are already troubled. Yuan devaluation means even more steel imports from China into India.

Output prices in China have been falling for over 40 months in a row - a symptom of over capacity. It's natural that Chinese firms would be looking overseas markets to push sells. Moreover, downward pressure on factory gate prices in China will force neighboring countries to follow suit or lose market shares. This means that ASEAN, Korea, Taiwan as well as Japan will have to cut prices or face losing market share - not a good scenario for India especially when its merchandise exports is declining.

Indian government responded by increasing import duties on steel products by 2.5% from the existing levels. However, these duty hikes will not apply to India's FTA partners such as Japan and Korea, while Chinese steel exporters now will be helped by Yuan depreciation.

4. Post the Yuan depreciation, currencies of other economies like Malaysia, South Africa, Indonesia, Thailand and Russia have also weakened. Going forward, this will make it even more difficult for India's exports which declined by 5%, 12%, 14%, 21%, 15%, 20%, 16% and 10.3% in the last eight months starting from Dec 2014. If Yuan devaluation further puts pressure on India's exports, it may destabilize the rupee. This may create problems for businesses with un-hedged forex exposure.  Latest RBI data shows that external commercial borrowings from March 2014 to March 2015 increased by 32% to $181.9 billion. This is 38% of total outstanding external debt.

5. However, if India rupee holds ground given its better macro numbers, it would also mean lower rupee cost of imported inputs such as flat rolled aluminum and steel, mobiles and components, power equipment for infrastructure companies, and cheaper Active Pharmaceutical Ingredient (API) for pharma companies.  

6. If rupee falls because depreciating Yuan or may be declining India's exports, it will benefit the net exporting sectors such as pharma, IT and textile.

7. Devalued Yuan and rate hike by US Fed would be too much for India to deal with especially when its merchandise exports are showing no sign to recover. Though better managed crude import bill and contained inflation are something to feel good about but risk to further slide in rupee remains.

8. The biggest dilemma: to let rupee sink to save exports and safeguards domestic businesses or raise interest to save rupee that will stifle growth when corporate investment is just not picking up.

Please share your thoughts on how Yuan devaluation is going to impact India and its industrial sectors. Also share you thoughts on how to deal with the situation.