China is one of the largest world’s economies that was hit by the Stock market crash and change in the value of US Dollar which led to the currency crisis in the country. China is a centrally planned economy, that is the government controls everything and does not let market forces influence the currency value in any way, sets the value of the Renminbi (Yuan) according to the closing value of US dollar every day. As the value of US dollar rose in the international market due to the monetary policy adopted by the United States Federal Reserves, the value of Yuan also grew as it was directly connected to the US dollar. Due to which the value of Chinese products became costlier.
China is a manufacturing and industrial hub and it has a competitive advantage over other country products mainly because of their low cost. The increase in the value of Yuan led to lesser exports for the exporters leading to lesser profit, because of which China faced huge export losses. China also tries to show more development in terms of the economy by building up ghost cities. That is, it is seen that the Chinese economy is developing in terms of infrastructure, but then there is no actual demand for these cities, as these are not at an affordable price for the citizens.
Another reason for the Chinese economy fall was the SHANGHAI (Chinese stock market index) dropdown leading to an inadequacy of margin calls for the borrowed money. The Real GDP growth in China experienced a good amount of rising in the year 2006-07 and fell during the global recession of 2008 and has been growing steadily since 2010.In 2015 Chinese growth dip below 7%.
In the last couple of years, to stimulate growth Chinese government had relaxed restrictions on its domestic stock market. Thus making it availing to more working class citizens as well. The middle, the working classes were able to earn more returns by investing their savings in stocks. There were approximately 90 million stock traders in China. In which around 67% of the investors holding less than high school education lacked proper knowledge to analyze the stocks. This led to two things mainly,
One: it led the value of Chinese companies to a highly inflated level and
Two: in order to attract more investors in the highly competitive market, banks and other fund manager promised high profits which were unrealistic.
The investors borrowed money from banks along with their own money to buy equity shares in the stock market. The main condition put for this borrowing was that, in the case of a fall in the price of the securities purchased with the loan amount the bank alone won’t be responsible for bearing the loss.
The percentage of money put by the investor in the total equity price is called the margin money. Due to the rise in the value of the Yuan, this decreased their exports, leading to lesser profits led to fall in prices of securities. For which the bank asked the investors to put money for the short falling to which they would liquidate the securities to recover the amount of their margin. This process is called a margin call.
This situation resulted in banks selling more shares in the open market to regain the value of margin money. The investors started to pull out of the markets in the fear of losing the value of their securities as well as banks recovering their margins. Which led to bad economic performance as the manufacturing hub faced huge losses.All of this led to the stock market crash in June 2015 the SHANGHAI index plunged from around 5100 points to 3700.
As an immediate solution this, the government enabled devaluation of the currency to calm the situation.
(Devaluation means a reduction in value of a currency in respect to another currency, ex: 1$ is equal to 5 Yuan, when devaluation is done then 1$ will be equal to 5.5 Yuan. This shows Yuan has been devalued in comparison to the US dollar. The main objective of the devaluation of Yuan was to boost up the exports as the Chinese products would become cheaper across the globe and an added advantage of attracting FDI’s across the globe.)
Impact on India:
- Oil prices have already surged down globally, with the US-IRAN deal, the economic slowdown has given a light push to lowering the price further.
- Automobile industries might face losses as China was one of its fastest growing markets.
- Auto-ancillary companies also might face loss as Chinese consumption will fall.
- As China is one of the largest producers of electronics, electronic goods will get cheaper.
- The competition on Indian exports will get tougher as Chinese goods are getting cheaper.
- The decrease in the value of the Yuan has made China more attractive compared to India in terms of Foreign Direct Investment.
- China already is leading India in terms of consumption of Gold. There is almost 36% increase in Gold imports comparatively year-by-year. This clearly shows that Chinese investors have decided to invest in safe funds like Gold after the China crisis they faced.
Overall export based economies will be hit badly as the Chinese goods will get cheaper.
And debts also will get cheaper due to the devaluation, i.e. the devaluation of Yuan means more Yuan for the same US dollar. Thus, there would be decreased in a number of payments to foreign investors.
Since China is one of the biggest economies among the developing country, its downfall might affect most of the economies throughout the world. The Most realistic solution to this crisis could be currency devaluation of 10-15 further which would help in gaining more export growth and develop inflation that could ease the financial leverage by paying off debt. They could also adapt to domestic consumption like India in order to encourage their manufacturing instead of solely relying on export.