China's decision to devalue its currency and boost slowing exports have raised fears that the move might spill over to economically challenged countries – that the country's `beggar-thy-neighbor' trade policy would pose an even bigger challenge to its trading partners.
While neighboring Kazakhstan has already floated its currency, letting the Kazakhi tenge drop by a whopping 23 per cent in one day, India and other Asian countries are expected to follow suit.
Reserve Bank governor Raghuram Rajan has already hinted at the possibility of the RBI letting the rupee depreciate further, and also warned against competitive devaluation by central banks, which would only damage the global financial system.
The recent international developments give a suitable opportunity to undertake a gradual depreciation. The recent Chinese depreciation could only spur such action.
The Chinese central bank explicitly said that the yuan is currently overvalued by 10 per cent. RBI seems to have taken note of the fact that no emerging market economy has prospered with an overvalued exchange rate.
In fact, governor Raghuram Rajan has reiterated a warning that the RBI would not hesitate to counter any long-term plan by Chinese authorities to push the yuan down and thereby gain a price advantage to boost exports.
The RBI is now expected to restrain itself from supporting the rupee by forex sales, rather confining itself to mopping up forex in times of heavy capital inflows.
For the RBI, the dollar peg of the rupee and its inflation fight could be a deterrent in allowing rupee depreciation, although under the RBI-government agreement on the Framework of Monetary Policy, the RBI has agreed not to countenance a depreciation of the rupee.
The exchange rate should, however, reflect the macroeconomic strength of the Indian economy vis-à-vis the economies of major international currencies.
Meanwhile, stock prices plummeted on Thursday as China's decelerating economy and the Fed's hesitant take on the US domestic recovery stoked fears of global recession and sent investors scurrying for cover.
The Dow Jones industrial average tumbled 2.1 per cent to 16,990.69, hitting its lowest level since last October.
The S&P 500 posted a similar drop, falling to 2,035.73 and putting it into the red for the year.
The tech-heavy Nasdaq, however, recovered to close at 4,877.49 after falling 2.8 per cent.
In China, the Shanghai Composite Index fell 3.4 per cent on Thursday on the back of the yuan's devaluation that began on 11 August.