Saturday, January 9, 2016

[Editorial # 37] China’s contagious economic turmoil : The Hindu

[Following editorial has been published in The Hindu on 9th January 2016. Read through it and try to answer the questions that follow. Please do not copy and paste answers. The objective of this exercise is to get you in the groove of answer -writing. Try to write in your own words. Don't hesitate to write in a bulleted-format, if you are uncomfortable in writing in paragraph form.]
China’s transition to a ‘new normal’ rate of growth was always expected to be bumpy. But, as it shifts gears, the Asian giant is spilling pain on to the rest of the world, and volatility is about the only certainty in the global economy at the moment. The yuan’s depreciation on Thursday to its lowest level since 2011, again put stock markets and currencies worldwide under pressure. Investors fear other countries could now be forced to consider competitive currency devaluations. The depreciation was less unexpected than the devaluations in August and is in line with Beijing’s move to make the yuan — all set to become a reserve currency of the International Monetary Fund — more market-linked. There’s a fresh worry: China’s foreign exchange reserves shrank by $108 billion in December, the biggest monthly drop on record, and declined by $513 billion last year. To put this figure in perspective, India’s foreign exchange reserves added up to $350.4 billion on January 1. The accelerating outflows from China, investors fear, could also be a sign of the country’s deepening troubles. China is rebalancing its economy, shifting it away from a model of debt-fuelled infrastructure and low-cost exports towards lower but more sustainable growth, driven instead by domestic consumption and services. Reformers in Beijing want to slow the Chinese economy, which expanded at a frenetic 10 per cent annually before 2008, and by about 7 per cent more recently. As the world’s second largest economy goes through a recalibration, the question increasingly being asked is: are the authorities in Beijing in control of the transition?
The scale and span of China’s trade gives it an over-sized influence over the global economy. Its waning appetite for commodities and imports is hurting economies dependent on such exports. For India, though, the drop in international commodity prices, especially of oil, is providing a silver lining as it is a net importer. The pain for India will come from the big and growing trade deficit it has with China. The deficit, which was $48 billion at the end of March, had reached $36 billion in the first eight months of this year and could worsen with the yuan’s depreciation. The Indian government must recognise that the depreciating yuan is a threat above all to Prime Minister Narendra Modi’s ‘Make In India’ plan. Indian manufacturers already suffer significant cost disadvantages. Their competitiveness will now diminish further against imports from China. Under the burden of China’s slowdown, global trade itself has shrunk. Recovery continues to elude the world more than seven years after the financial meltdown in 2008 and the subsequent monetary easing worldwide. India must recognise that the global economic scenario is far from healthy and take steps to spur domestic growth.
1. Explain the following terms/expressions
  • Rate of growth
  • Depreciation
  • Currency Devaluation
  • International Monetary Fund
  • Monetary easing
  • Trade Deficit

2. Why are investors worried about devaluation of Yuan? 
3. What is meant by slowing down of an economy? What could be the reasons for slowing down of Chinese economy?
4. What is meant by reserved currency of IMF? Which all currencies are currently the reserved currency of IMF? What are the criteria for getting a reserved currency status for any particular currency? 
5. What does the editor mean when he says that China is rebalancing its economy?
6. Would a slowdown of Chinese economy impact the global economy? How?
7. How would Make in India program be impacted by devaluation of Chinese currency?
8. A increasing trade deficit between India and China is cause of concern for India's economic growth. Discuss (200 words)
9. A depreciating Yuan is not a good sign for Indian economy. Comment (200 words)


  1. 1. Explain the following terms/expressions
    Rate of growth:- It is the change in the value of revenue over a period of time. Generally it is measured in %. growth rate is calculated for GDP to measure the state of economy rate of growth= end value- origninal value/ original value.
    Trade deficit:- trade consists of imports and exports. If value of imports is > exports , it is called as trade defecit. if value of exports is > imports it leads to trade surplus.
    Depreciation is the reduction in the value of the asset/currency etc. over a period of time.
    3. currency devaluation:- when any country decides to lower the value of its monetary units, it is called as currency devaluation. This happens when govt voluntarily increases the supply of the money through intervention.
    It is established in 1944 and a fallout of brettenwood's conference to facilitate short term loans to the countries facing BOP crisis.
    Monetary Easing:-Monetary easing is a type of currency intervention where a nations central bank either keeps interest rates artificially low or expands the money supply by making open market purchases of its own sovereign debt.

  2. 7. How would Make in India program be impacted by devaluation of Chinese currency?
    Currency Devaluation done by china recently is to boost its exports . This means there will be lot of manufactuing and employment opportunity. Hence this increases the FOREX of china as the investors are attracted. This means there are high chances of forex shift from india to china. Hence this leads to the reduction in investment in indian shares. Thus it impacts the MAKE IN INDIA by siphoning the investments getting into india.

  3. 5. What does the editor mean when he says that China is rebalancing its economy?
    A china recent moves shows a paradigm shift from exports driven economy to the welfare oriented economy. But now the devaluation of currency takes back to square one. Hence the rebalancing of the economy means that the china is increasing its exports while contracting the imports.

  4. 1. Explain the following terms/expressions
    • Rate of growth: It may be defined as the amount of increase that a specific value has obtained within a fixed time period. It may refer to exponential growth, economic growth or even population growth rate.
    • Depreciation: It is the decrease in monetary value of a tangible asset over a period of time due to wear and tear, unfavorable market conditions, etc. Appreciation is the opposite of depreciation where the value of the asset increases with time.
    • Currency Devaluation: Currency devaluation occurs when the value of currency of a particular State declines with respect to another or more currencies. It leads to greater exports and decline in imports of the nation. However, it has negative consequences for other countries in the long run, since other nations will not be able to export goods due to their higher rates and may be forced to devalue their currency as well.
    • International Monetary Fund: It was created along with the World Bank in 1945 as a financial branch of the United Nations overlapping the World Bank. It monitors exchange rates and stabilizes international monetary systems. Failure of one economy can have a domino effect on others as well and the IMF works actively to avoid that by providing loan to troubled economies.
    • Monetary easing: It is a type of currency easing where the Central Bank of a country floods the economy with cash and decreasing interest rates artificially to ensure flow of money in the economy to boost the economy growth. However, there is also a risk of inflation as a result.
    • Trade Deficit: Trade deficit is said to occur when the net imports of a country are greater than the net exports of the country, which in turn means foreign exchange going out of the country. Nations can curb this by either trade barriers to reduce imports or currency devaluation so that local products flood the market.

  5. 7&8.India’s growing trade deficit has become a cause of concern for the country with the gap now being over $48 billion which was also voiced at the 7th BRICS Academic Forum in Moscow. This deficit is a result of China’s policy shift from a primary products base to a manufacturing regime. Concern for trade deficit led to India’s adoption of the local manufacturing rules in 2010. India’s ban on export of iron ore is deemed to be one of the contributing causes to the deficit. However, India contends that transparency should be maintained by the Chinese Government in procedures related to registration, inspection and approval of goods.
    An alternate view could be that devaluation of currency might be beneficial to some industries, at least in the short run. Since procurement of equipment for setting up industries may be done at low prices, establishment of industries will be easier. Consumers will have a plethora of choices to buy from. Additionally, although the ‘Make in India’ program may suffer due to devaluation, one could learn something from China’s ability to manufacture goods at competitive prices. On the other hand ‘Make in India’ campaign suffers because even though goods may be produced at cheap rates, the market for them will diminish due to two reasons. Firstly, countries will try to restrain imports to reduce chances of trade deficit and secondly, to avoid flooding of markets with low cost exports crushing the local producer.

  6. 9.• India is China’s rival in textiles even though it is moving onto high-end textiles. Towards the lower end, the profit margins are narrower and the devaluation will hit profits.
    • Indian steel companies will also be hard hit due to the lower price of China imported steel.
    • Most of the electric equipment is acquired from China and since Indian companies do not pass on the difference to the consumer, they will gain from it.
    • Mobiles, laptops, toys etc are also imported by e-commerce dealers from China and reduced prices mean huge sales in the coming days.
    • The Rupee has also fallen in response to the devaluation owing to which inflation will increase.
    • Since India already runs a trade deficit with China, the current account deficit is also bound to increase.
    • Since India and China also compete against each other in a sale for a large number of goods, Indian exporters also stand to lose.
    Overall, the Indian producer will be the loser due to China’s currency devaluation and government controls would be needed to protect the local manufacturer.

  7. 3. Manufacturing index in China has slowed down over the past few years showing contraction of the manufacturing sector which could affect the global economy. The Chinese economy is suffering from an over capacity problem due to over-investment in infrastructure, mostly. Global slowdown meaning reduced demand from EU, Japan and South Korea has affected Chinese exports. China is the largest producer of steel and exports huge quantities of it. Concerns over the environment have affected demands for construction grade steel hence affecting Chinese economy.

  8. 3. (contd)
    The rate of economic growth of an nation is measured by determining the percentage change in the GDP during a specific period of time.

  9. 4. Also known as anchor currency, it is commonly used in international transactions and is considered a safe haven currency. It is held by governments as foreign exchange reserves. US Dollar is the major reserve currency presently making up 60% of all forex reserves. The Euro comes second with nearly 30% of all forex reserves. Countries such as United States have an added advantage in international transactions, since they do not have to buy currency, benefiting them to an amount of $100 billion each year.
    US Dollar, Euro, Pound sterling, Japanese Yen, Swiss Franc, Canadian Dollar and the Chinese Yuan are the reserve currencies of the world.

  10. Rate of growth- it is the amount of increase within a specific period and context that a specific variable has gained.
    Depreciation-it is decrease in value of assets over a period of time or decrease in value of currency when compared to other currencies because of unfavorable market conditions.
    Currency Devaluation- it is an intentional move by a particular country to reduce the value of its country downward when compared to other currency or group of currency.
    International Monetary Fund- It is an international organization which was formed in 1944 at the Bretton Woods Conference. It formally came into existence in 1945 and had 29 members. it is headquartered in Washington. It was formed with an objective to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. Countries contribute money to the organisation through Quota system. Any country who is facing difficulties of balance of payments can borrow money from the institution.

    Monetary easing- It is an action or a method taken up by the central bank to boost money supply and increase or stimulate the economic activity. This is done by central bank by reducing interest rate so that borrowing becomes easy.
    Trade Deficit- This is basically an economic condition wherein a particular country is importing more goods when compared to its export. It is calculated by value of goods being imported minus value of goods being exported, it is calculated in the currency of the country in question.

  11. China’s move to devalue its currency will lead to competitive devaluations around the world and especially among the countries with which china trade.
    It further puts pressure on the central banks around the world to push down their own currencies to help their own exporters and to prevent destabilizing capital flows.
    Further it is going to hurt commodities markets as there is a signal that the there is a potential weak demand from china. It could also accelerate capital outflows out of China, especially if investors expect further devaluations.
    And lastly there is a probability that other countries will try to emulate China which will start a currency war in international trade. Vietnam Followed in china's shoes to weaken its currency in response to china.

  12. According to China the devaluation was done to give market forces a considerable say in the exchange rate that was being called by the United States and the International Monetary Fund for long.
    China’s yuan was rising for a decade due to which its economy became the second largest in the world. The devaluation was a downward adjustment.
    Move is being explained as one of the key reforms that allows the market to handle the currency's value.