While we in India were completely taken over by the Article 370, Trump continued being who he is and his administration called out China a “currency manipulator.”

Yesterday, the Yuan fell after Trump escalated the China tariff war on Sunday – he proposed a 10% tariff and the yuan showed a natural reaction – it too fell and the Chinese Govt did not intervene to arrest the fall. Maybe that is what Trump is calling as “manipulation?” China also halted new purchases of American agricultural goods, mainly soya bean.

Just as Trump is “protecting” his country, the People’s Bank of China, its equivalent of our RBI, decided to deal with Trump’s next round of tariffs by letting its currency weaken past the psychologically important point of 7 renminbi to the American dollar for the first time in more than a decade. The fact that there was no move to arrest the fall is what Trump is calling manipulation.

Naturally Trump is miffed. China’s reaction is not different from what any other country – it allowed its yuan to weaken against the dollar which makes its exports cheaper, helping it offset the impact of the tariff. Trump was crying hoarse as the weak yuan makes American exports expensive, especially those which are competing head-on with China. These were pure market forces at play. And given what Trump is doing, did he expect China to merely bow its head and accept, allow him to hurt their already hurting industry?  Make no mistakes, China is no saint and its way of business is questionable but then, US knowing this, decided to make China its bed partner, with so much of both countries now intertwined, a break-up now will cause a lot of bad blood and pain for all around. The direct damage to China and USA plus the collateral damage to others is big.

China used to control its yuan till 5-6 years ago but after it devalued the currency in August 2015 and then again 6 months later, it has refrained from manipulating. When China devalued its currency then there was a virtual global rout thus this current fall of yuan has caused so much nervousness.

Devaluation of a currency helps a country, when in trade balance trouble, to lower the cost of its exports. The purpose of this devaluation is to thus improve trade deficit and imbalances through higher exports and lower imports. Chinese companies, especially in realty and heavy industries have borrowed heavily from banks in US dollars and for them a falling currency does not bode well. Also it will make oil expensive as it is priced in dollars too; overall, a devaluation could mean that the wealthy Chinese will pull money out of the country. Thus, even for China, a yuan which goes spiraling down will not work but it will do whatever it takes to retaliate.

Do you know why this trade war has escalated and caused this fall across world markets? It’s a “punishment” for China because it refused to make large scale purchases of soybeans. So Trump, acting like a spoilt child, said he will now impose a 10% tariff on another $300 billion worth of Chinese goods. Following this, China has now said those purchases will not happen any time soon. And the world is caught between the sparring of these two.

Trump had, in July considered weakening his own currency but then decided against it. Then he asked the Fed to lower rates but by proposing this 10% tariff, to begin from 1^st Sept, he has rendered the rate cut meaningless. Another tariff hike means Chinese economy gets weaker and that means the US dollar gets stronger. When the dollar firms up, one can buy more of a commodity with the same dollar amount, trimming the demand for that commodity and in turn the price. Price of imported goods into America, when the dollar is strong, will fall which in turn forces down prices of higher-priced equivalent domestically-produced goods, bringing down inflation. This is counter-productive to the what the Fed tried to do.

Thus if the yuan continues to fall and the dollar gets stronger, Fed might be forced to cut rates more than it would want to do to maintain growth and inflation.

Either way, the Chinese play a far longer game than Trump, whose only modus operandi is based on stimulus and reflexive, visceral response. As is so often true, Trump is out of his element and completely ill-equipped to deal with the challenge. And the world should fear an irrational, provocative response yet.

Well, how does all this impact India? Yuan devaluation is sure to put pressure on the Indian Rupee though it is not aligned with Chinese yuan; so there will not be a direct hit to the rupee but the effect will percolate through the dollar. Companies exporting to China will earn lesser while imports from China will cost more, so metal companies in India could be hit. Yes, the dollar will get stronger and that would bode well for exporters and IT companies.

The Chinese turmoil is cure to affect Indian markets – it is more psychological but then markets are always all about sentiments, aren’t they? With no real trigger coming from within, surely the fall of Chinese yuan will have a more magnified effect here.