The biggest cause of global trade imbalance around the world is currency devaluation.
China, without devaluing its currency, managed to peg the dollar at 6.83 renminbi from July 2008 till June 2010, which has given a huge boost to Chinese exports. US and European exports have become less competitive.
This, in fact, has resulted in a huge trade deficit and fiscal deficit in countries like Greece, which have become highly dependent on Chinese exports. With increasing trade deficits and unemployment, developed economies started to feel the pinch and pushed the Chinese Government to appreciate its currency. This has started happening, albeit slowly.
The currency conflict flared up in 2010 when Brazil criticised the US for weakening the dollar through quantitative easing.
The focus in the recent past shifted to Japan as the new government has targeted a weaker yen as part of its efforts to lead the country out of deflation. The yen has fallen 20 per cent against the dollar since September 2012. The speed and volatility of the adjustment has surprised many.
The expansionary monetary policy pursued by US has led to its currency depreciation with reference to the euro; as a result Southern Europe has already started facing a loss of competitiveness.
As per a Deutsche Bank estimate, French companies suffer at a threshold where the dollar is at 1.24 to a euro and Italian companies when the dollar is at 1.17 to a euro.
The downsides of a currency war are clear. The easiest way to devalue a currency is to increase its supply.
This increased supply of hard cash will attempt to make their way towards stocks, real estate, commodities and government bonds, resulting in asset price bubbles. The increased flow of capital will further complicate currency management.
Interestingly, the rupee has remained by and large stable in recent months. This trend is a sharp contrast to the nervousness witnessed in mid-2012 when the rupee was almost in free fall.
Is the rupee level a real reflection of the fundamentals, or is it just the making of a bigger crisis?
The rupee has gained at a time when the current account deficit (CAD) is 5.4 per cent of the gross domestic product (GDP). India needs about $80 billion a year to fund the gap on the current account deficit at the present level.
Therefore, if the numbers are anything to go by, the rupee should have been depreciating. But that is not the case, and the reasons are not very difficult to identify.
The developed countries are busy competing with each other in devaluing their currencies and, as a consequence, flooding the world with cheap cash.
Some of it is landing on Indian shores as capital flows. Strong volatile FII inflows are bridging the gap created by the CAD.
However, this easy money will not last forever, and even if it does for a considerable period, it poses a different set of challenges.
A sudden stop or a slower pace of inflows can quickly turn the tables on the rupee.
Though the liquidity in the global financial system is expected to remain comfortable, surprises in fragile economic conditions can emerge anywhere, anytime.
Even if it is assumed that India will keep borrowing easy by liberalising the capital account to fund the current account and push currency to higher levels, the idea is being increasingly questioned.
As per the former Deputy Governor, RBI S. S. Tarapore, with our inflation rates persistently above that in major industrial countries, the present dollar-rupee rate should be close to Rs 70.
Recently, another foreign exchange expert commented that the rupee should be at least Rs. 60. While this debate can go on, considering the present global macroeconomic scenario and the fact that India is a major importer of oil, we cannot afford either huge appreciation or depreciation from the present level.
REAL ECONOMY STEPS
To attempt this, we need to do the following urgently amongst others;
Improve the competitiveness of the indian industry by addressing infrastructure bottlenecks.
To give an example:
The average cost of moving the container even within India is $945 against the Chinese cost of $450 and Vietnam’s $625.
The turnaround time for a ship in any port India is considerably higher as compared with even some of the neighbouring countries like Sri Lanka.
We need to remove all the constraints which come in the way of farm exports. Ashok Gulati, Chairman, Commission for Agriculture Costs and Prices, has recently stated that we can earn an additional revenue of $20 billion by liquidating excess grain stock of almost 40 million tonnes.
Our policy on agri exports has always been short-sighted.
We have a great opportunity to push the export in ASEAN countries. There is a huge scope for increasing export in areas like processed food, health care products, IT, etc.
India’s record in increasing the production of crude oil and gas is extremely poor. After huge delay, we have permitted Cairn to increase the production of Crude oil in Rajasthan.
We need a strategic tie-up with Russia and countries in Africa to acquire certain oil and gas fields.
Our options in defending the exchange rate either way are limited, given our liquidity situation and the fast reducing reserves.
(The author is President & Group CFO, TAFE Ltd. Chennai. The views are personal.)