On January 1, 1994, the Chinese currency Yuan was devalued from 5.4 to a dollar to 8.27 to a dollar. The intention at that time was to revive the sagging economy through improved exports. China succeeded immensely. The number of jobs created in China along with their huge foreign reserves since devaluation justified this course of action. A similar situation is now currently arising in China. Will China decide to devalue is the moot question. Let us look at the facts.
According to London-based consultants of Charles Dumas, the current economic slowdown will soon drag down GDP growth below 5% in the near term. Mark Faber, another well-known consultant is predicting an economic growth rate of 4%. If it turns out to be true, it will be a major shock to the global economic growth agenda. A growth of below 7.5% target also complicates President Xi Jinping’s effort to shift China to a service based economy from an export and investment led one.
As before, President Xi may choose to lower the exchange rate to boost exports to buy time to recapitalize the economic growth. Achievement through capital spending on infrastructure reached an unsustainable 42% of GDP, given the consumer spending is around 36% of GDP.
Lesson 1: The infrastructure spending can only be sustained if the consumer expenditure is maintained at a higher level.
Now, the next issue is the level of Chinese corporate debt which has touched $14.2 trillion. The major banks in China carry nearly $1.65 trillion of this debt. Clearly, this is not sustainable. Borrowing more to gin up growth is not the option. So, President Xi may use devaluation as an option. However, he may have to exercise caution. Only after much persuasion from the US, China allowed its currency to appreciate 11% against the dollar. If they decided to devalue, then Korea and Japan, who are their trading competitors may also join in the currency war and engage in competitive devaluation.
China has come to realize that growth only through exports and infrastructure development isn’t the only choice available but could shift to achieve growth through promoting domestic demand. The global economies except the US are slowing down. The Eurozone is already in recession. Japan hasn’t gotten out of recession. With China slowing down, we can expect 2015 to be a below-average year for most of the economies of the world. Every country will try its best to get out of this mess as rapidly as possible. Adjusting to the new reality will always call for major policy changes. So we shouldn’t be surprised if China, indeed, decides to let its currency go down in value against the dollar.
Our PM Modi is keen to revitalize the manufacturing activity in India. In this global economic slowdown, this is a great challenge and let us hop he succeeds.
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