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China Throws Currency Fireball to have Minor Impact Rupee

August 12, 2015

China throws currency fireball in a surprise move by devaluing its currency by 1.9 pct. After this move market must be anticipating wave of global devaluation and loose monetary policy. There is a huge risk that currencies of China’s trading partner could come under severe pressure after Chinese move to weaken its currency. It has given jitters to the global stock market, which stayed in red.

Today’s move by Peoples Bank of China may challenge FED to consider delaying US interest rate hike. This move could be tough for Japan trying to get out of long recessionary period and stimulate its economy. Since last almost couple of years BOJ opted for quantitative easing (QE).

Similarly, in March this year ECB fearing deflationary pressure, eased to the lowest level in a hope that easing would pave way for European business to penetrate other part of the globe.

Until today, Yuan was in ascending mode and was on constant climb that was helped by 10 pct plus growth, which lasted for more than 2-decades. Like all Central Banks China’s Central Bank (PB of China) tried to calm the market by saying this is one time action, but the big question is that what is the purpose? What will this devaluation achieve? And what is the guarantee that weakening of Yuan by 1.9 pct will help in reforming Chinese economy.

Immediate reaction was seen Asia as regional currencies, Indian Rupee, South Korean Won, Indonesian Rupiah, Malaysian Ringgit and Australian Dollar came under severe pressure.

China’s devaluation raises quite a few eyebrows, as the country is very keen that Yuan should join Special Drawing Rights (SDR) basket (US Dollar, Euro, Pound Sterling and Japanese Yen), which requires that the currency move should be market based with no Central Bank interference. The IMF SDR basket review is due in next few months time. Therefore, from now onwards, market will keep a close and tight watch on Chinese currency to see if the currency is moving freely or being managed.

Since Chinese currency is allowed to trade in a 2 pct either way band, 1.9 pct devaluation means PBOC can argue that it did not violate, as the currency move was within its acceptable band.

Recently market witnessed Chinese regulator injection nearly USD 147 billion in past 2-months to prevent meltdown. Despite falling oil prices that has fell by more than 50 pct, its economy is struggling. China’s oil import is well above 6 million barrels per day. Its exports are unable to make recovery. Investors are afraid to enter Chinese market. Whereas, it’s trading partners dependent on Chinese imports are having spillover effect.

I think China is making every effort to increase its overseas business activity, but as long as global demand does not pick up. Chinese economy would continue to struggle. China does have a 1.3 billion population largest in the world, but growth in its domestic market may not be sustainable for the economy to respond. Its foreign exchange reserves have already plunged to USD 3.65 Trillion.

Meanwhile, in Pakistan we may be trumpeting about reaching economic wonders due to tags awarded, by rating agencies, donor agencies, Bloomberg and Forbes. But in reality, it is self inflicted wounds that may add to our woes. For the real economic direction, ideally keep a close watch on four things. Rising domestic and external debt numbers, SBP liquidity injection amount through OMO and Circular Debt, which is the most appropriate barometer for economy watch?  While hats off to remittances for supporting economy and let’s hope that it does not start getting squeezed by next FY due to falling oil prices.

However, Pak Rupee could come under minor pressure due to weak regional currencies, which will be short lived. But weak Rupee is not the answer to our problems. Reforms, pro growth and unbiased strategy are the answer to our problems.

Meanwhile, with shift in Chinese stance, global economic strategy is bound to take a flip. Hence, SBP is required to reconsider its policy stance, make a shift towards accommodation in real sense as per SBP Governors MPS and adopt soft approach.

I do not fear big surge in inflation numbers, which is unlikely to surpass 4.25-50 pct by the calendar year end and hence, more rate cut and slash in coupon rate is unavoidable.

@asadcmka

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