The 'Dragon' finally bows! - Views on News from Equitymaster

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The 'Dragon' finally bows!

Jul 25, 2005

After months of intense speculation and discussion, China finally yielded to global pressure and let the Yuan appreciate, albeit by a marginal 2% from its decade long peg to the dollar of 8.28 to the current 8.11. While the rate of appreciation is not significant, it assumes importance in the sense that it signals possibilities of a further appreciation in the pegged currency. The Chinese have also indicated that the Yuan will now be pegged to a basket of currencies and not just the dollar. In this write-up, we will take a look at the global implications and what this means for India. Global implications
The revaluation impact will be beneficial to the Asian currencies in the sense that these Asian nations will now be willing to let their respective currencies strengthen, with China having finally initiated the move. Japan will also stand to benefit as Japan's exports make up 15% of China's imports. Overall, it will mean that Asian exports will now be more competitive. The US had been consistently reiterating the fact that the Chinese currency was undervalued, consequently hurting the US exports. The US is already facing the problem of swelling twin deficits, which was the leading cause of the dollar's huge depreciation against the global currencies towards the end of 2004. Therefore with this latest move, the US is likely to ease the pressure on the Chinese government to a certain extent.

Indian implications
RBI governor, Y.V Reddy had in an interview mentioned that a revaluation of the yuan was unlikely to have an adverse impact on India's economy and might even help trade competitiveness. It must be noted that the Indian currencies as well as other major Asian currencies were losing out on the exports front as the decade-old Chinese peg led to cheaper exports from the Chinese mainland. The rupee has been on an appreciating trend since the end of 2004, chiefly driven by FII inflows and even at times influenced by the rise of the global currencies against the dollar. However, RBI intervention kept the rupee from appreciating at a steep pace. Therefore, consequent to the Yuan revaluation, appreciation of the rupee is not likely to have an adverse impact on India's exports. However, it will mount the pressure on the RBI to intervene in case of a very fast rise in the rupee.

Sectoral impact
Oil:In the recent months, oil prices have skyrocketed touching the US$ 60 per barrel. Since, India imports around 70% of the oil that it consumes, any appreciation in the Indian currency is beneficial to the oil firms, which will now have to buy dollars at a cheaper rate to import oil.

Software:Since the Chinese currency has appreciated by only 2%, software firms do not expect the revaluation and consequently a stronger rupee to adversely impact their business. However, it must be noted that severity of the impact will depend on the extent of the exposures and how well the software companies have hedged the same.

Commodities: A stronger Yuan would mean that, for China, imports will be cheaper. This means that the demand for steel and other commodities will be on the rise. However, considering the fact that China is already facing a situation of a supply overhang and is in fact a net exporter of steel, textiles, chemicals and other commodities, it really remains to be seen how the Indian commodity companies are likely to be benefited by the same.

Our view
It must be noted that the steep appreciation in the major currencies against the dollar after the Yuan revaluation was a knee-jerk reaction influenced more by the surprising element of the move rather than the scale. However, since then the dollar has recovered its losses as the focus once again shifts to the economic fundamentals. While the latest move by China is not likely to significantly impact India, it remains to be seen whether China will go in for a further revaluation in the future and the extent of the same. However irrespective of the Yuan revaluation, if India Inc. continues to show strong growth and FIIs continue to pump in money into the economy, rupee is poised to get stronger. Therefore, it all boils down to what risk management measures, companies are adopting to hedge against the same.

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