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    Global Currency War and India - General Analysis Shared by an Indian Writer

    Don’t count the dollar out of the global currency war” is the statement made nobody else but Janet Yellen, US Fed Chairwoman recently. The Fed’s language was strikingly out of line with market expectations. This is also an unconventional statement as US has not very forthcoming in accepting the fact that it has unleashed a currency war through slow and gradual depreciation of dollar since 2010. The unconventional monetary policy started by USA in the name of quantitative easing has now become the other name of currency war.

    Taking a leaf out of US book, European Central Bank (ECB) recently adopted a similar kind of approach after it found Japan also has successfully ridden the wave of quantitative easing. Officially Japan has always been in a denial mode about currency war. ECB started an asset purchase program which over 19 months would amount to asset purchase of 1.14 trillion euros (870 billion). Mr Draghi, the ECB President, said asset purchases will start to include the purchase of bonds issued by euro area governments and agencies and European institutions. This is expected to bring Euro Zone out of deflationary pressure at a time when the entire zone is under a negative inflation of 0.2% and growth rate have slowed down significantly.



    While long term impact of quantitative easing is yet to be ascertained, the short term impact is clearly visible now. Euro, as a currency, fell sharply against dollar this year. It hit 12 years low of EUR 1 = USD 1.05 before USD again started weakening, prompted by approach adopted by Federal Reserve. This has also meant that Euro automatically depreciated against other leading currencies making other currencies appreciate and this in turn has hit emerging economies. There is another side of quantitative easing effect. Currency dealers, and the ubiquitous computerized trading robots, are influenced far less these days by growth or inflation forecasts than by the market’s view on the origin of the next splurge of quantitative easing. Quantitative easing has made policy makers think and analyse potential impact of disguised currency war on their economies.

    Some countries like Korea and China have recently resorted to interest rate cuts to propel their economies but impact of interest rate cuts have laggared effect and that is why they have to wait and watch. But there is no denying the fact that monetary policy easing is also another form of war which is meant to propel economic growth by lowering cost of capital. The idea here is to provide necessary push to the slowing economy by pumping more money at lower cost, which, in turn may have nominal inflationary effect pushing up production and exports.

    While the entire developed and developing world watches impact of currency wars, India a key emerging player in the global economy cannot remain isolated. India faces a dual challenge of managing her balance of payments as well as boosting growth through exports. Internal and external signs of economic parameters are not very healthy. Despite of significant fall in the crude price, the trade deficit for April-January, 2014-15 was estimated at US $ 118373.95 million which was higher than the deficit of US $ 116532.22 million during April-January, 2013-14. Industrial production has not really taken off and inflation is showing signs of revival. Success of “Make in India” program is depends not only on more internal production but is also based on creating platform for more exports. Amidst all these challenges, remains the biggest challenge of managing Indian rupee, which has shown huge volatility during recent few months.

    Where does India stand in this currency war? How does the currency war harm India? What are steps that should be taken by India to nullify impact of currency war on Indian economy? These are some of the questions that need analysis and a possible answer. There are some dilemmas that also need an answer. From policy perspective a sudden fall in rupee value does not augur well for the economy as it dilutes faith of foreign investors but at the same time an appreciating or long term stable currency makes exports noncompetitive and imports cheaper.

    As a developing country India can ill-afford to ignore currency war. There is a potential that the currency war may harm India’s export as well as the domestic economy. Foreign fund inflow is one of the key requirements for success of Indian economy but ongoing currency war has the potential to derail it. So what are the options before the country?

    One of the key areas which have attracted huge inflow of money in India has been the money of foreign institutional investors (FIIs). In 2014, India could attract $43 billion plus of FII inflow in first nine months of the year. This happened primarily because of the reason that there was a huge interest rate differential between US and Indian economy. Government security yield in US for a 10 year bond was around 2% which was more than 7.8% in India during this period. This seems to be an area which may see reversal of trends as US is likely to increase the rates while India is going to cut rates in future. Also this inflow was more of hot money in the economy.

    To supplement the loss arising here, the government must encourage long term investments through foreign direct investment route (FDI). As per data published by Department of Industrial Policy and Promotion (See Chart Below), FDI inflow in has gone up but it is still insignificant compared to China.

    If today China stands relatively insulated from currency war, it is more because of the fact that FDI inflow in China has been very robust, creating a huge investment inflow in China in terms of foreign currency. However, attracting FDI could act more as a long term measure than short term measure.

    Last but not the least, the Reserve Bank of India (RBI) should also continue with measures of market intervention to tighten and loosen Indian currency value depending upon the market dynamics. Additionally, there is no harm in letting Indian rupee depreciate to some extent, especially if the real purchasing power of currency has gone down. After all, strength of a currency is not its value alone. Unfortunately in modern times, currency manipulation has become a tool to propel economic growth.

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