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The Chinese Yuan and India’s Monetary Policy

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Chinese yuan devaluation

The People’s Bank of China, which fixes the reference rate of the yuan daily, surprised everyone by devaluing its currency three times last week. One of China’s key rationales behind this strategy is to boost exports, which fuel the Chinese economy.

But with this move, China may have just launched a currency war. If it hasn’t yet, a fourth yuan devaluation would certainly do the deed.

In any case, these moves by China are already pressuring the RBI (Reserve Bank of India) to reduce its repo rate once again. How? Let’s explore.

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India under pressure

India’s exports were already under pressure due to weak demand from the global economy. Though a fall in crude oil prices has been helping reduce Indian imports, the Chinese yuan devaluation could put further downward pressure on Indian exports, which would weaken the Indian rupee, as shown in the highlighted portion of the graph above.

In part 2 of this series, we examined how expansionary monetary policies intend to increase economic activity, and how rate cuts serve as tools for such expansionary monetary policies. But in addition to fostering accommodative conditions, rate cuts also have an impact on the domestic currency. Usually, the value of the local currency unit falls in response to a rate cut. This fall helps make domestic goods cheaper in the international market than before, potentially boosting exports.

The present currency volatility is already affecting the revenues of information technology companies like Infosys Limited (INFY) and Wipro Limited (WIT). And if the Indian rupee doesn’t weaken further, it could impact petrol and diesel prices, which, if sustained, could hurt auto companies like Tata Motors Limited (TTM), among others.

Falling exports, a rising import bill, and lower corporate revenues—losses that would lead to lower tax collection by the government—would further influence India’s economic growth. These factors would have subsequent impacts on India-focused ETFs like the iShares India 50 ETF (INDY) and the iShares MSCI India ETF (INDA), among others.

In the last article in this series, we’ll take a deeper look at India’s exports.

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