Is The Indian Rupee’s Fall Connected To Chinese Yuan’s Movement?

The Indian rupee is set for its biggest monthly loss in 6 years in August. The Chinese yuan has also gained a lot of attention this month after the highly controlled currency fell to levels not seen since February 2018. So is their movement really connected?

What caused the rupee's weakness?

The rupee and the Indian markets have been known to be resilient to the global economy's status. Experts say that the recent fall in the rupee is linked to the weakness in the domestic factors that have magnified between July and now.

The slowdown in economic activity and consumption (largely evident in the auto sector) and the withdrawal of funds from foreign investors sent the equity benchmarks tumbling.

It has been observed the movement of the rupee is usually in line with the market. Any positive development in the economy generally benefits both the parameters.

However, this week, despite the two positive boosts to the Indian economy-1) revoking the surcharge imposed on higher-income in Budget 2019 and 2) RBI's decision to transfer a surplus of Rs 1.76 lakh crore to the government (which will bring down India's fiscal deficit for the current year significantly), there wasn't a great deal of recovery seen in the rupee.

Experts feel that the blow of US-China trade war, that has hurt many major emerging market currencies, could partially have to do with the fall in the Indian rupee.

The yuan's fall

It has been a tough month for the Chinese yuan after trade tensions between the US and China intensified. It was at its 11-year low this week. The People's Bank of China set the midpoint at 7.0810 per dollar on Tuesday. Unlike other major currencies, yuan has two exchange rates-

• onshore yuan-which trades only on China's mainland and is heavily controlled by its central bank which allows the exchange rate to stay within a narrow band of 2 percent above or below the set "midpoint rate" (which is adjusted daily). If it deviates, the PBOC will buy or sell yuan to keep the currency stable.
• Offshore yuan- it trades more freely and mostly in Hong Kong, but also in Singapore, New York and London. It was seen trading at 7.16/dollar level on Wednesday morning.

The Chinese currency is highly stabilized to prevent capital outflows that China has faced in the past, as all developing markets do. When currency levels fall too rapidly, investors move their assets out of the country to reduce their losses.

The recent fall in the yuan's value is a given, considering the effect of the trade war on the country's economy, which reported a fall in its GDP growth for the June quarter to its slowest in 27 years. A CNBC report said that companies are looking at alternatives like Thailand amid the increased tariffs, to cut on operational costs.

How will the yuan's weakness hurt the Rupee?

The biggest concern, as pointed out by the US, is that a weaker yuan makes Chinese imports cheaper for its customers, thus reducing the impact of the tariffs imposed on them. Whether or not this is being done intentionally is debatable as the country is often preferred by investors for its stability in terms of government and policies. So it is highly unlikely that China will allow the currency to float too far. Further, the country has also been looking to internationalise its currency so that it can become a top reserve currency, like the US dollar.

Still, the fact remains that it increases the appeal for China's products in comparison to its competitor's (which includes India) products. However, the rupee has lost more in value in a month than yuan has in a year.

The concern now is that the future of rupee is being linked to yuan, then the earlier call to link its performance to more trade-oriented Asian currencies like the Korean won.

In a recent note, JP Morgan said, "If the CNY continues to depreciate against the USD, as we expect, we believe the rupee will depreciate virtually lockstep with the CNY." This is because the rupee is showing signs of tracking the yuan.

The August currency trend

Another factor to consider is that the month of August has been historically weak for the currency markets, especially the emerging economy currencies. This is because traders in major currency trade centres are known to take vacations in the month. Bloomberg data shows that rupee has slipped an average of 2.3 percent in August over the past nine years.