Tuesday, August 11, 2015

Currency Manipulation subsidy!

Chinese foreign exchange reserves stand at $3.65 trillion. US foreign exchange reserves stand at $113 bn!
Chinese debt stands at ~$5.2 trillion. US debt is ~$18.3 trillion!
Yet, China choses to devalue its currency by more than 2% w.r.t USD!
The devaluation raises some questions.
The WTO norms seek for gradual removal of subsidies and also the other economic barriers surrounding any trade between nations. But isn’t the currency devaluation a form of subsidy being extended by the Chinese Govt. to its industries. Subsidies are generally extended in the form of tax exemptions, lower credit or moratorium periods or relaxed accounting guidelines. But an exchange based subsidy (Currency manipulation subsidy) is something that the Chinese Govt. is exploring, if not the first time, to its full potential.
Why Can’t other countries chose to do so. Because most of the other countries have a mix of imports and exports and by de-valuating their currencies they are risking the increase in imports and hence inflation. China has lot more exports than imports and hence can afford to do so. Chinese in a single shot have gone ahead of their competitors by more than 2%!!
Now, what does it mean for markets around the world. For sure, all the goods from China would become sweeter and more companies would vie for that. Increased discounts in USA and other countries as they have a bigger leverage now.
Countries like India which are trying to compete by establishing their manufacturing basis will find it increasingly tough to do so. Already the devaluation alone is expected to increase the imports of Steel to India from China by ~17%. At best countries can aspire to become assembly stations of the manufactured goods from China.
Even for countries like USA, you’d hardly find the possibility of any rise in local manufacturing thwarted by this.
Is it any good for other nations at all?
For any country which is planning to import, this is probably the best thing. And all other exporting nations which are trying to compete with China, this is a big big news!!
What about China? Is it good for them?
Yes and No. Yes because the export oriented industries will continue to benefit. No, because suddenly credit in USD becomes costlier and increased cost of commodities will have its impact on inflation and costs of goods. One would have to wait and watch, if the increased revenue from exports will outweigh the rise in costs. Credit and loans for companies will not be a real issue as China will ensure that most of the industries that are significant to its economy continue to receive credit at lower rates thereby taking away that risk.
What does it mean for Energy and other industries?
Since most of the commodities are traded in USD, it may not really impact a lot to commodities. More so, Chinese will continue to tap more into their own local resources and so it may be at best a good news for local mining and other companies in China. For sure, the supply chain and logistics industries will probably see a major shuffle in the short term to medium term range.
What about USA?
Many listed companies in US will continue to produce more goods from China as this will show a positive increase in their bottom lines. But any revival in local manufacturing industry will take a big hit. Expect to see big discussions/debates about this subsidy in the upcoming US presidential elections, since a weaker Chinese currency would mean lesser jobs within US in the conventional industries.
Looks like, overall its a smart move to alleviate any immediate fears about its economy. It’d be interesting to see how other countries will respond.