InvestorQ : If the Chinese Yuan weakens, why does the rupee also weaken? What is the link between the Yuan and the INR?
manisha Kolvenkar made post

If the Chinese Yuan weakens, why does the rupee also weaken? What is the link between the Yuan and the INR?

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Mahima Roy answered.
8 months ago

You would have seen in 2015 and then again in 2018 and 2019 the Indian rupee broadly followed the weakening of the Chinese Yuan. Why does the Yuan weakening lead to a weakening of the rupee too. Here are a few reasons why they move in tandem.

a) Both the Yuan and the INR are pegged to the USD. Therefore any weakness in the USDCNY leads to weakness in the USDINR also. It has been observed that the Yuan weakness has normally been accompanied by a strengthening of the Dollar Index (DXY) which impacts the rupee. Thus the link comes through the US Dollar.

b) China is a major trading partner for India and hence the weak Yuan also has major consequences for our trade. It must be remembered that India runs its largest trade of $60 billion with China. Indian producers of steel and radial tyres are already complaining that they are unable to compete with Chinese imports. A weak Yuan will only worsen this problem for Indian manufacturers.

c) Most of the emerging markets across Asia, Africa and Latin America have a strong trade relationship with China. For example, countries like Brazil, South Africa, Malaysia and Russia are major exporters to China. When the Yuan weakens, all these emerging markets are forced to drop their currencies to stay competitive in the global trade market. This forces India to jump into the currency fray.

d) The bigger worry is that the weakening of the Chinese Yuan may put the Indian economy in a Catch-22 situation. Let us see what it means. When the Yuan weakens, the rupee is also forced to weaken to stay competitive. However, that has negative implications for foreign portfolio flows. India saw nearly $10 billion of outflows in the last fiscal year largely because of rupee weakness. That is not something Indian economy with its rising fiscal deficit, can afford.

e) Finally, the Yuan weakness also has larger implications for interest rates. Since the rupee would weaken with the Yuan, the only option for the central bank is to keep real interest rates high to attract foreign portfolio investments. That explains why Indian continues to have one of the highest real rates in the world.