DEVALUATION OF YUAN

DEVALUATION OF YUAN – Why this could be the beginning of the end for the global boom?

Devaluation means to reduce the value of currency in a fixed exchange rate mechanism.It simply implies that value of currency in terms of foreign currency will fall.

China recently announced the devaluation of its local currency Yuan.Its distressed the financial markets all around the world by doing so.This was done to ensure that its exchange rate mechanism is in terms with market oriented approach.On 11^th August 2015,Yuan’s value dropeed 1.9% followed by a further 1.6% decline on 12^th August.This was the biggest decline in a day.But was it a good move?Let’s check out the pros and cons of the same for Chinese as well as other economies-

PROS

1) China’s foreign exchange reserves are in a very good position.So,this devaluation will help in stabilizing the economy and may not even result in capital outflows on a large scale.

2)At this point of time,the commodity market faces a tough price environment.So for giving a boost to economic growth,higher aggregate demand and exports are needed by China which is possible through devaluation.
3)When a currency devalues,the exports beacome cheaper.Being cheaper,they become more competitive in the foreign market.Domestic demand increases.As a result more jobs are created in the export market solving the problem of unemployment.
4) If a country faces a huge current account deficit because of its lack of competitiveness,then devaluation helps in reducing this deficit.
CONS

1) China’s debt denominated in the US dollar will not gain from devaluation.It would in turn make it expensive to repay the huge debt of $1.1 trillion that has been owed by the firms in China.

2)This sudden shift in fixed mechanism at the People’s Bank of China gives a hint of market based fixing system.

3)How this fix is going to be estimated?Well this is a question full of uncertainty and because of this,the markets all over the worls are anxious and distressed.
4)When imports become more expensive due to devaluation,the aggregate demand leads to demand pull inflation.
5)Devaluation for a long term can reduce the purchasing power of residents abroad.Moreover,it may also reduce productivity in the long run due to fall in incentives.

CONCLUSION

As long as this decline in the value of Yuan is moderate,the merits are greater than the demerits.But is should not be a spiky decline.It is possible that in the furture,yuan will internationalize due to a better two way floating exchange rate.This devaluation may also prove beneficial for world economy as it can reduce the downward pressure on Chinese economy.

DID YOU KNOW?

Renminbi is the official currency.It was introduced by People’s Republic of China when it was founded in 1949.Yuan is just the name of a unit of Renminbi currency.However,usage of both is perfectly fine.

Click here for government certification in Accounting, Banking & Finance