India-China trade, not all about the currencies - DBS Group Research

As the Chinese yuan weakened for a third successive day, the Indian rupee fell past the crucial 65/US dollar to two-year lows yesterday. Part of this was likely a catch-up in the Indian unit's relative outperformance so far this year.

Despite the latest adjustment, rupee is still amongst the best performers in the region on quarter-to-date basis. India is amongst the least dependent on China as an export destination in the region (DBS; 'Asia: new drivers, new risks'; 2Aug13), which underscores its relative stability vis-à-vis, other AXJs.

Nonetheless there are concerns that weakness in the Chinese yuan might hurt India's trade competitiveness. This is especially relevant as the yuan's weightage in India's real effective exchange index is high in both the 36-currency and 6-currency trade-weighted basket. In this regard yuan's recent fall notionally adds to real rupee gains and might prompt the authorities to be more tolerant of modest near-term weakness in the INR/US dollar.

We take this further to understand implications on bilateral trade between India and China. India has run a sustained trade deficit with China, which jumped from USD 0.7bn in FY00 to USD 48bn in FY15 (see chart). Do recent yuan moves imply a wider trade balance going forward? Not necessarily so.

Past trends show that currency movements have not been the main catalyst for bilateral trade between these two countries. In fact, since 2009 when India's trade deficit (with China) doubled from USD 19bn to USD 48bn last year, rupee has lost more ground than the CNY. The rupee depreciated more than 40% against the Chinese yuan and down 30% vs US dollar. In addition, as our Currency economist notes in the 12/Aug Daily note, the CNY had been too strong in recent years, both on real effective exchange rate basis and broad dollar direction.

This suggests that the deterioration in India's trade balance with China was driven by factors beyond just currency movements. Bulk of India's recent imports from China has been electronic products, machinery, mechanical and metallurgic, chemicals, amongst others. Demand for these were likely driven by lower import landing costs, easier access / availability, limited logistical constraints and unsuitable domestic alternatives.

India will also need to check these boxes to be successful in its efforts to revive an export-oriented manufacturing policy, under the Make in India initiative. A cheaper currency will only be half the battle won.

Source : Equity Bulls

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