In what was a stunning move the Chinese authorities on Tuesday decided to devalue the Yuan. The objective was to revive economic growth in the country.
In most countries like India the currency is traded freely in the interbank foreign exchange market. In China the currency has been linked to the US dollar. It then allows the currency to trade in a fixed band.
The devaluation ensured that the Yuan rate against the dollar was lowered to 6.3306 from 6.2298 the previous day.
How does it affect India?
Let's give a simple example on what happens to India. If an Indian is exporting a shirt at $1 and so is a Chinese exporter, India and China are competing in the international markets. Let's assume that the Chinese gets 75 (just for comparison sake) for the yuan against the dollar and so does the Indian exporter. Now, if the Chinese drops his currency by almost 2 per cent, he get 76.5 to the dollar. This means he can sell the shirt for less than a dollar and cheaper than the Indian exporter. This could hurt the Indian exporter as he remains no longer competitive and people would prefer cheaper imports from China.
Now, it could affect in many other ways. A lot of steel is imported by India from China. When there is a yuan devaluation the Chinese could sell steel cheaper and people would end up buying Chinese steel in place of steel manufactured in India. This would affect the domestic industry in India.
But, the good thing that has happened as we write is that the Indian rupee has also depreciated against the dollar, though not as much as 2 per cent.
But, India cannot afford to let its currency depreciate dramatically as it could increase the cost of oil imports, make petro and diesel costly and ultimately fuelling inflation in the country.