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Sandeep Jain writes: The devaluation of the Yuan, Chinese stock market clash as also the resultant impact on Indian stock markets and the weakening of the rupee have been much in the news.

Sandeep Jain writes: The devaluation of the Yuan, Chinese stock market clash as also the resultant impact on Indian stock markets and the weakening of the rupee have been much in the news. Large numbers of newspapers have covered it and intense debate is currently on. Speculations such as, whether this is the beginning of the end for the current dispensation in China, whether this signals a global slowdown etc have been doing the rounds. Property bubble, infrastructural overcapacity and similar terms have also been discussed. Only a person with a reasonable understanding of economics can really make out as to what is the actual problem and what is going to be the impact on India and reasons for devaluation of the rupee.

However, I have tried to understand the reasons for this phenomenon and the likely impact.

First let us examine the reasons for the devaluation of the Yuan. Unlike India, Chinese currency is not fully convertible. Thus the value of the Chinese currency is partially controlled by the state. There have been charges earlier that the Chinese have deliberately kept their currency undervalued. This had led to the Chinese products being cheaper when bought in any other currency such as dollar. On the flip side the imports, cost of foreign travel etc was costlier. Thus by keeping the currency devalued the Chinese are paying more for the imports of goods like oil. One of the probable reasons for further devaluation of Yuan was therefore to give a further boost to their exports as china has an export oriented economy. It would also make investment in China further more economical for any foreign firm who may set up their factory in China and thereafter sell the finished goods elsewhere in a different currency. Presumably, both FDI and exports were slowing down prior to this devaluation.

Crash of Chinese stock market! Why did that happen? The Chinese banks had large non-performing assets in terms of loans to state owned enterprises which were not doing well. Real estate was also not doing well due to overcapacity. The present political dispensation thus wanted the industry to generate its own revenue by going public. This took away the pressure for state funding. The public therefore was actively encouraged to invest in the stock market. However, investor greed drove the markets to unrealistic valuations and a correction was overdue. The devaluation of Yuan only provided a trigger. In fact the devaluation was meant to boost exports thereby enhancing the valuation of the industry and making equity holding more profitable in the long term. However, the exact opposite happened due to the present valuation being too overpriced. To make industries even more viable, consumption within the domestic market should also grow. This is yet to fully takeoff. The Government is thus faced with a difficult situation wherein, the stock market debacle will further spur the domestic population towards saving rather than spending. The Chinese government is therefore trying its level best to protect the stock markets. Ordinarily stock markets reflect the state of the economy. However, the Chinese stock market crash must be viewed more as a correction, rather than a prediction of doom for the Chinese economy, which continues to grow, albeit, not at the same pace as before. Part of the problem also stems from the fact that unlike India, the Chinese do not have high domestic penchant for gold. The retail investor had only the options of stocks, property and government securities. Since property had reached a plateau and the government securities do not pay high interest, stocks had become a lucrative option.

Why is the Chinese economy slowing down? Most of the reasons have been articulated in various media reports such as, not enough internal consumption, ageing population, reducing demand in Western markets. I would like to add a few more reasons. First of all it is difficult to maintain very high growth rates indefinitely. Chinese have sustained near double digit growth for a long time. It is bound to slow down even if the growth story continues in real terms. During past, the growth was spurred by unceasing infrastructure development. This seems to have hit a plateau now. In fact the public debt accumulated for this infrastructure development may have now become unsustainable. China is not yet the pioneer in research and innovation-something which has spurred the growth in the Western world. Similarly China has remained dependent on net import of energy. In spite of a growing military and economic might it has not yet become the net provider of security in the region. China also still does not have dominant control over institutions such as IMF etc. The Western economies, whose industrial production had slowed down significantly specially for cheap goods, have revived their manufacturing sectors thereby reducing dependence on Chinese goods.

Is India going to be similarly impacted? There are significant differences in the Indian narrative. That is probably the reason for financial analysts to remain bullish on India. The Rupee is fully convertible. This had led to a significantly higher import bill. Probably the decision for full convertibility was taken with a view to enhance our exports. Our economy is a diversified economy. Even though we are labelled as a services economy, our jugaad economy has diversified interests. Being a large domestic market we are also insulated to foreign economic developments to some extents and our large workforce is only growing younger. Indian economy will continue to grow based on these domestic parameters. The crash of our stock markets was probably an emotive reaction coupled with a slight correction which was due. Also our markets are affected by behavior of FIIs to a larger extent than China. The markets will recover.

If I was to make a prognosis, the Chinese growth story is far from over. The prophesies of impending Chinese doom are also unrealistic, even though competing interests would try to pull them down to the extent possible. Chinese economy has remained the dominant economy of the world throughout history except for small blips. The only scenario where China may have a major setback is if in case the political system also collapses. As long as the leadership is in control, this will be like a storm in a teacup which China will endure.



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