Currency devaluation happens when the country drops the value of its currency with respect to other currencies. What this means is that if a few days ago you got $1 and bought five yuan if you devalue the currency today you could get much more yuan for a dollar.
China on Monday devalued its currency which surprised the global markets. It devalued its currency, the Renminbi (RMB) or Yuan, by nearly 2 per cent.
Why did China devalue its currency?
The People's Bank of China's (PBC) spokesperson said that "For the purpose of enhancing the market-orientation and benchmark status of central parity, the PBC decided to improve quotation of the central parity of RMB against US dollar."
China's currency is not freely traded as in other markets and is linked to the dollar. Its exchange rate was linked to the basket of currencies which was unknown and was strongly related to the dollar.
The country's authorities felt that it needed to be dropped or devalued to bring it in tune with the markets. They felt that the RMB was overvalued and was hurting Chinese exporters as it was making their products more expensive overseas.
From now, its daily quotes will be derived from the previous day's closing rate of the inter-bank foreign exchange market and on currency supply and demand in the market.
This will help in conjunction with demand and supply condition in the foreign exchange market and exchange rate movement of the major currencies.
Impact on Other countries
The global stock market reacted negatively to the devaluation news. US stock markets plunged as a weaker yuan may reduce exports of U.S goods to China and may make Chinese goods cheaper vis a vis domestically manufactured goods.
After devaluation, the country's exports may become cheaper and imports expensive.
Impact on India
Yuan devaluation can have some impact on India's exports as there can be a possibility of cheaper imports in the Indian market from China.
Domestic manufacturers may get hurt due to large imports of steel, power equipment and other products.