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Global markets rattled as China devalues yuan

China on Tuesday devalued the yuan by 1.9%, the steepest in over two decades, rattling global currency and stock markets, reports Saibal Dasgupta. It raises prospects of further pressure on Indian exports, which have declined continuously for the past seven months.

The surprise cut in the daily reference rate, along with a change in methodology, announced by the Chinese central bank is seen as an attempt to deal with weakness in the economy and regain competitiveness in a world that has seen other currencies depreciate more in recent months.

The “one-off” move triggered the yuan’s biggest one-day drop since China ended a dual-currency system in January 1994.

Following the announcement, global currencies ranging from the South Korean won to the Australian dollar weakened against the US dollar. The Indian rupee weakened by 32 paise to close at near two-month low of 64.19 to a dollar.

International stock market indices too were lower, with the BSE sensex closing 0.8% or 236 points lower at 27,866. US Treasuries gained on growing demand for dollar assets, while global commodity stocks sank.

Market analysts are watching closely how central banks and government in other countries react to ensure that their currencies remain competitive, amid renewed fears of a global currency war.

For Indian policymakers, the yuan devaluation is the latest bad news as exports have declined for seven months in a row. “In my opinion it should have some impact on our exports. Exports from China would be cheaper… It may also have impact on FDI if China becomes a more attractive destination vis-a-vis India,” finance secretary Rajiv Mehrishi told reporters.

Some analysts said this was a sign that Beijing would now allow the market greater freedom to trade and find the bench mark price for the yuan. China is also sending a signal to the IMF that the yuan is now ready to be included in the basket of currencies for its special drawing rights, some economists believe.china_currency_xmm82_c0-117-3802-2333_s561x327

China’s move also has raised fears of a “currency war” as export rivals seek a weaker exchange rate to stay competitive, according to Stephen Roach, a senior fellow at Yale University and former non-executive chairman for Morgan Stanley in Asia.

“It’s hard to believe this will be a one-off adjustment,” Roach said. “In a weak global economy, it will take a lot more than a 1.9% devaluation to jump-start sagging Chinese exports. That raises the distinct possibility of a new and increasingly destabilizing skirmish in the ever-widening global currency war. The race to the bottom just became a good deal more treacherous.”

For China, economists said, the devaluation had become necessary. Exchange-rate intervention contributed to a $300 billion slide in China’s foreign-exchange reserves over the last four quarters. It also made the yuan the best performer in emerging markets, a factor behind last month’s 8.3% slide in exports.

The yuan’s real effective exchange rate – a measure that’s adjusted for inflation and trade with other nations – climbed 13% over the last four quarters and was the highest among 32 major currencies tracked by Bank for International Settlements indexes.

Growth in China, the world’s second-largest economy, has slowed this year and is set to hit a 25-year low even if it meets its official 7% target.

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