TO BEGIN WITH:
Markets world wide cheered this move by rising robustly the next trading day.
In simple terms, Yuan will trade in a wider band in the currency markets compared to erstwhile rigidly monitored rate by the Chinese Government.
A FEW WORDS ABOUT
During 2005-08, the Yuan appreciated 21% when
To protect its exports from sub prime crisis volatility, China temporarily entered once again into fixed exchange rate regime in July 2008 (peg of 6.83 Yuan/$).
Chinese bankers blamed the peg for disrupting money markets.
Now, after export growth has made a decent recovery ( there is a 45% YoY growth in May), China has now opened up the gates for gradual floating of Yuan exchange rate amid mounting pressure from bi lateral trade partners with G 20 Summit due this month end but with caution.
US Economic Experts felt Chinese Yuan is currently undervalued by almost 40%.
In March, US President Obama warned
There has been tremendous pressure on
WHY THIS PRESSURE ON
Ballooning trade deficit of US,
Once Chinese exports become expensive because of stronger Yuan, US will return to domestic production and consumption. Also, US exports too will rise since Chinese goods will be no longer cheaper. This will help US to bring down its trade deficit over a period of time.
Flight of capital from US,
World cheered Chinese move because they felt there will be restoration of economic balance i.e., economic realignment and proper distribution of capital and profits.
Also, another reason why
- With appreciated Yuan, the purchasing power of
automatically rises. It can import foreign goods and commodities at lower prices and increase domestic consumption. This is one reason why metal prices rose in the markets after China announced Yuan appreciation. China has huge demand for commodities and just to quote an example imports billions of yuan of iron ore every year. China
- Stronger Yuan would boost domestic consumption in
reducing its dependence on exports. China
- A stronger Yuan means neighbouring countries would be willing to trade in Yuan and hoard Yuan. Thus Yuan will gain prominence in World trade transactions.
- Chinese corporations having dollar debts will benefit. Example, Chinese Eastern Corp, China’s 2nd largest airliner profits would rise by nearly $40 million yearly for every 1% annual yuan rise because of devaluation of its US $ debt.
- Morgan Stanley feels a 5% rise in Yuan it expects in 2010 will result in positive 2% rise in Chinese corporate earnings.
- On the flip side, Chinese exports will be affected especially in textiles, electric and electronic components (Deutsche Bank says a 10% Yuan rise will result in 3.7% fall in textile exports and around 2% fall in components).
- Appreciation may result in capital flight from
which may eventually result in loss of jobs and lesser consumption and lower GDP. China ’s falling growth may again disturb the world economic equations. China
HOW WILL REST OF THE WORLD BENEFIT:
In export of textiles, leather products and handicrafts the competition between
Capital inflows into
Countries exporting goods and services to
US feels that if Yuan was more expensive than $, American domestic production would rise and the
If prices of spare parts imported from
Free floating exchange rate will result in automatic adjustment of balance of payments position. Free floating rate is determined by free markets. This will take a long time for Yuan for it to be totally market driven.
Markets have become silent after an initial thumps up because now what is bothering the economic system is European Sovereign Debt Crisis on the bigger picture. Yuan has already strengthened 18% against Euro wiping out profits of Chinese exporters. Around 16% of Chinese exports are to EU while they are around 13% to US.
The final word is, Chinese Yuan Appreciation is good for
CA. SIVAPRIYA V L TENNETI
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