Currency
wars – Will spoil the Party
A country’s Currency
strength determines its competitiveness in the global trade. Strength of a
currency in determined by Fiscal deficit, Trade deficit, Forex reserves and
capital flows in an economy.
The economies where the
foreign reserves are very high, trade
surplus is there and positive capital
inflows in the economy, currencies have a tendency to appreciate. The countries
where there is high trade deficit, negative capital flows, negative current
account are likely to witness depreciation in currency. Depending on the
situation, countries resort to manipulation of currency by either buying or
selling dollars. Buying dollars lead to appreciation of currency and selling
dollars lead to depreciation of currency. Extent of buying , Selling determines
the level of appreciation / depreciation.
Currencies which are weak,
provides the cost competitive advantage to nations in gaining share in global
trade. China gained lot of advantage in the global trade by keeping its currency
weak for long, supported by artificial depression of Cost of production in the
country. This helped China to become the leader in manufacturing in the world.
After the pressures from US and others, China allowed the appreciation of
currency .
The advent of Trade war now
is posing a big challenge to nations across the world. Trade war will lead to
slow growth in global trade and many of the nations which mainly depend on
trade will be affected in a big way. To counter the trade war, Countries will adopt the strategy of weakening their currency.
This year, China’s remnibi
already weakened. After a fall in 2016, renminbi witnessed appreciation in the second half of 2017. It lost momentum
in early 2018 due to slowing economic growth and the escalating trade dispute
with the US. The renminbi depreciated by 3.2% against the US currency in June
alone, its worst-ever monthly performance. This will lead to exchange-rate
volatility . China will continue to allow the depreciation of its currency if
the trade wars continue.
A similar trend was
witnessed by many of the emerging economies where they saw their currency
depreciating against the dollar. Currency depreciation leads to inflation since
the imported commodities cost more. If trade wars continue, even, other large
exporting countries will start depreciating their currency. This will lead to
currency wars.
When the countries want
their currency to remain stable to ensure a stable economy, they resort to buying dollars, which results in appreciation
of currencies. This will help in making the
economy stable and helps importers
.
When
countries want to increase the competitiveness of products, central banks sell
dollars in large quantities, which leads to depreciation of the local currency.
When a commodity exporter, a manufactured product exporter or a service
exporter , benefit from this move, Since their sales is dollars or equivalent
and when the proceeds are realised in India, they will be able to make good
profit.
Since April the US dollar has rallied and market expects Fed will
accelerate the pace of monetary tightening and expects US interest rates to go
up ,which will make reverse flow of capital from the Emerging economies.
In line with the emerging trends, Indian currency also witnessed a fall
. Rupee depreciated by 7% from Rs 64.50 to a dollar on June 23 to Rs 69.05 on 24 July, a
very sharp depreciation. India has a huge current account deficit and fiscal
deficit. Indian Economic growth was supported by capital inflows in the last
few years , when the interest rates in global markets and US were very low. Now
that US has started increasing the interest rates, some of the capital which
flowed to Indian Economy will go back. This will put a pressure on rupee.
Many experts believe that Indian Rupee
will not depreciate beyond Rs.70, since RBI intervenes at regular intervals to
keep the rupee stable, which will ensure the stability of the overall economy.
There are predictions that it could touch Rs.72 also if oil prices rise further
and our trade deficit continues to show a
rising trend.
If the trade wars continue, it will be a challenge for India to keep the
export competitiveness high . Allowing rupee to depreciate , will lead to
inflation. In the last three , four years, inflation was contained. Now that we
are in the election year, the currency has to be kept stable. It will be a
challenge for Policy makers in the area of currency management and Trade
management. We have to be ready with solutions for each possible scenario , so
that inflation is contained, our economic stability is maintained, our exports
are competitive.
