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Chinese Yuan highly undervalued

Chinese Yuan highly undervalued

While, there is a plethora of factors that govern the value of a currency, the overall economic health of a nation sets the long term perspective for the currency. However, other factors like government control may block the free movement of the currency and its trading value may not reflect its true value.

Let’s take the example of India and China. India’s currency is not fully convertible and its value is determined by a managed float. Under a managed float, the central bank of a country intervenes in the Forex markets by buying and selling foreign exchange so as to avoid sharp fluctuations in the domestic currency’s value. However, a managed float usually reflects the true value of the currency sans sharp fluctuations. In effect, the central bank soft lands the domestic currency. The strong growth that India has experienced in the last decade is well reflected in the value of its currency, which has gone up from INR 49 to the US dollar to INR 43 to the US dollar over the same period.

China on the other hand has not allowed its currency to appreciate even though their economy has posted exuberant growth. This is well reflected in the huge foreign currency reserves that the country has accumulated. The chief reason for this is that if they allow their currency to appreciate, their export produce will become more expensive for their trade partners and China will lose out substantially on their export income. Exports as of now are China’s main GDP growth driver and China is extremely averse to allow its currency to appreciate. Viewing this in another way, China’s
undervalued currency gives it an unfair trade advantage over other nations that compete for the same export market. Hence, China is facing pressure from several countries to allow its currency to appreciate and align to its market value. Of late, China has succumbed to the pressure and allowed a minor appreciation in its currency, but a huge correction is overdue.

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