What is Currency War- A primer -30.04.16

by Dr. Akhilesh Tripathi

Currency WarCurrency War

National Seminar on Global Economic Outlook : National Seminar on Global Economic Outlook : Resilience & Sustainability of Indian EconomyResilience & Sustainability of Indian Economy

Organised by Organised by School of Management –Poornima UniversitySchool of Management –Poornima University

April 30, 2016April 30, 2016

Sharing of Thoughts on


• Cold War

• War on Terror

• Currency War


In its financial stability report, published on December 23, 2015, India's Financial Stability and Development Council (FSDC) pointed out that developments in China and the dilemma of the US Federal Reserve on its interest rates, along with competitive quantitative monetary easing policies of central banks across the world, might trigger a currency war.

What Is A Currency War And What Is A Currency War And How Does It Work?How Does It Work?

A currency war refers to a situation where a number of nations seek to deliberately depreciate the value of their domestic currencies in order to stimulate their economies.


Currency War- manipulation of currencies to boost exports.

Currency War - competitive devaluation, is a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency.

What Is A Currency War And What Is A Currency War And How Does It Work?How Does It Work?

Although currency depreciation or devaluation is a common occurrence in the foreign exchange market, the hallmark of a currency war is the significant number of nations that may be simultaneously engaged in attempts to devalue their currency at the same time.

Currency WarCurrency WarCurrency War – term first introduced by Guido Mantega, the finance minister of Brazil.

A lower value for the home currency will raise the price for imports while making exports cheaper.It significantly increase risks for cross-border trade and investment

Currency War- WhyCurrency War- Why

Two nations use their currency as a weapon to fight their war

Direct or Legal

Indirect or Illegal


Direct or Legal Direct or Legal

Direct war is when one country devaluates its currency or appreciate its currency.

The move is intended to bolster exports and making goods cheaper to purchase abroad


Indirect or Illegal Indirect or Illegal

Indirect wars are fought by printing fake currencies of that nation Or

artificial trading and devaluation of a currency by using illegal trading means

Currency War- WhyCurrency War- Why

Indirect or Illegal Indirect or Illegal

Indirect wars are fought by printing fake currencies of that nation Or

artificial trading and devaluation of a currency by using illegal trading means

Currency War-How it is doneCurrency War-How it is done

A country reduces the value of its currency in an effort to boost competitiveness by stimulating exports and economic growth

It makes its products cheaper on world markets


A currency war is initiated primarily by advanced economies.

The developing countries, which do not have much clout in the global economy normally dodge the bullet.


Affluent Country use its currency as an indirect monetary tool to achieve its domestic goals.

Developing countries, which are highly dependent on portfolio inflows to manage their current account deficit, suffer as a result of this.


China intervenes directly to depreciate or devalue its currency through peg adjustment

(the central bank sets a parity rate and allows it to rise or fall by 2 per cent from the mid-point on each trading day)


European Central Bank, Japan's central bank and US Federal Reserve

do it through rate adjustments and liquidity management.


Currencies of these countries are then used for carry trades in high yielding developing economies, and are withdrawn promptly when winds turn adverse


SOURCE: BLOOMBERG NEWS

http://www.bloombergbriefs.com/content/uploads/sites/2/2015/02/economicseurope_currency_wars_supplement.pdf

Currency War – Need for Currency War – Need for DevaluationDevaluation

• Correcting the price distortions.

• To increase competitiveness in foreign

market.

• To raise national income per capita

• Close the development gap.

• Restriction on commodity as well as

capital flows.

Currency War – Impact of Currency War – Impact of DevaluationDevaluation

• Improve trade balance

• Alleviate balance of payment difficulties.

• Accordingly expand output and

employment.


A weak currency increases the cost of imports, thus making domestic producers more competitive in the national economy, again driving growth.

However, there are problems with maintaining a consistently under-valued currency, not least of which is that it encourages inflation, which is itself detrimental to driving growth.

Currency War – Why Depreciate a Currency War – Why Depreciate a CurrencyCurrency

Strong Currency Vs. Weak Currency

A weak domestic currency makes a nation's exports more competitive in global markets, and simultaneously makes imports more expensive.

Higher export volumes spur economic growth, while pricey imports also have a similar effect because consumers opt for local alternatives to imported products.

Currency War – Why Depreciate a Currency War – Why Depreciate a CurrencyCurrency

Generally translates into a lower current account deficit (or a greater current account surplus), higher employment, and faster GDP growth.

Weak currency also have a positive impact on the nation's capital and housing markets, which in turn boosts domestic consumption through the wealth effect

Currency War – ReasonsCurrency War – ReasonsBeggar Thy Neighbor:

When nation A devalues its currency, nation B will soon follow suit, followed by nation C, and so on.

This is the essence of competitive devaluation.

Currency War – ReasonsCurrency War – Reasons

Economic growth in most regions has been below historical norms in recent years;

many experts attribute this sub-par growth to the fallout of the Great Recession.

Currency War – ReasonsCurrency War – ReasonsMost nations have exhausted all options to stimulate growth, given that interest rates in numerous countries are already either near zero or at historic lows.

With no further rate cuts possible and fiscal stimulus not an option (as fiscal deficits have come under intense scrutiny in recent years), currency depreciation is the only tool remaining to boost economic growth.


Bad for investorsAny depreciation of the rupee, however, is bad for foreign investors.

Currency War – Negative EffectsCurrency War – Negative Effects

Currency devaluation may lower productivity in the long-term, since imports of capital equipment and machinery become too expensive for local businesses. If currency depreciation is not accompanied by genuine structural reforms, productivity will eventually suffer.


The degree of currency depreciation may be greater than what is desired, which may eventually cause rising inflation and capital outflows.


A currency war may lead to greater protectionism and the erecting of trade barriers, which would impede global trade.


Competitive devaluation may cause an increase in currency volatility, which in turn would lead to higher hedging costs for companies and possibly deter foreign investment.

Currency War – Need for Currency War – Need for DevaluationDevaluation• Overvaluation of currency associated

with import substitution for industrialization as opposed to export promotion policies.

• The risk of losing competitiveness.

• To relieve an unfavorable balance of trade.

• Economic stabilization.

Currency War – Impact of Currency War – Impact of Yuan Yuan DevaluationDevaluation

Rupee volatility: If the rupee continues to fall sharply, imports will become costlier, stoking inflation

RBI will be forced to hold on to high interest rates- which will hamper the ongoing economic recovery.


Rupee volatility: India runs a trade deficit (imports are more than exports), current account deficit will also rise, which will further pressure the rupee. Falling rupee is bad for companies that have dollar-denominated loans and also for foreign flows because stock market returns become unattractive.

Currency War – Impact of Currency War – Impact of Yuan Yuan DevaluationDevaluationPressure on Exports:

Domestic Exports and Global Slowdown.

India and China compete for several export items - textiles, gems and jewellery, etc.

Economic slowdown in China - which is among the top five countries for Indian exports - is another negative for Indian exporters


Dumping of Chinese goods: Sharp devaluation in Yuan will help China dump goods into the Indian marketImpact domestic manufacturers

Market will react E.g. Tyre stocksSteel makers

Currency War – Why India will Currency War – Why India will not follow the suitnot follow the suit

High InflationForeign capital flowsHigh Cost Of CapitalEase of doing business in IndiaFocus On Innovation

Currency War – India’s Currency War – India’s PreparednessPreparedness

Foreign exchange reserves - $352 billion, enough to cover 10 months of imports.

One of the most favoured nations among global investors because of its strong macro-economic fundamentals.


Prices to rise only about 4 per cent yearly in the medium term

Fiscal deficit below 4 per cent of the gross domestic product (GDP)

Current account deficit is only about 1.2 per cent of the GDP.


Political certainty in the country

Oil prices have remained soft

Foreign direct investment is positive – Upto September, the FDI inflow was $26.52 billion, up 18 per cent from the same period last year.

Weaker Currency Good Or BadWeaker Currency Good Or BadA weaker currency can help an economy by potentially boosting exports, jobs and inflation, as well as increasing corporate earnings.

Where interest rates are already very low, a weaker currency has become a desired way to stimulate growth

Weaker Currency Good Or BadWeaker Currency Good Or Bad

Central banks are making aggressive moves to ease monetary policy—either by lowering interest rates or increasing the supply of money by purchasing government bonds (QE).

Increasing the supply of money can suppress the value of an economy's currency.

Currency War – HistoryCurrency War – HistoryIndian Chronology1947(when India became member of IMF): rupee tied to pound.

18 sept,1949: pound devalued; India maintained par with pound

6 june, 1966: rupee devalued, Rs 4.76=1$, after devaluation, Rs 7.50=1$

1971-1979: rupee is overvalued due to India's policy of import substitution.

Currency War – HistoryCurrency War – HistoryIndian Chronology

23 June, 1972: UK floats pound, India maintains fixed exchange rate with pound.

1975: India links rupee with basket of currencies of major trading partners. Although the basket is periodically altered, the link is maintained until the 1991 devaluation.

Currency War – HistoryCurrency War – HistoryIndian ChronologyJuly 1991: rupee devalued by 18-19%March 1993: exchange rate:1$=31.37

1993/1994: rupee is made freely convertible for trading, but not for investment purpose.

Currency War – Way ForwardCurrency War – Way ForwardCurrency fluctuations create uncertainty Crimp investmentCurrency pegs stabilize exchange ratesU.S. exporters down--economy at risk.

how long the world’s economies can fight, and how they might make peace in the currency wars.

Currency War – Way ForwardCurrency War – Way ForwardIndia ready to face the global currency war

With forex reserves enough to cover 10 months of imports and strong economic fundamentals, India can cope with depreciation, but is its currency policy on track

What is Currency War- A primer -30.04.16

Economy & Finance

Transcript of What is Currency War- A primer -30.04.16