Trade skirmishes have raised fears of a global currency war.
In this context, it is important to gauge its possible implications for India and other economies around the world with a historic precedent.
What did the 2008 Financial Crisis unleash?
Crisis - Immediately after the collapse of “Lehman Brothers Bank” in the US that kicked off the 2008 financial crisis, economic panic spread globally.
The biggest concern of countries then was to avert a sharp slide in their respective economic growth curves and prevent loss of jobs.
Actions - U.S. and members of the EU embarked on expansionary fiscal and monetary policies (spending more and keeping interest rates low).
To secure their growth, some countries turned protectionist in due course by introducing non-tariff barriers and occasionally raising import duties too.
Another strategy used by some countries was to either devalue their currencies, or deliberately keep the value suppressed in international markets.
Significantly, this helped them to keep their exports cheaper in the world market and thereby sustain international demand for their produce.
China, Japan and South Korea were noted to actively suppress their currencies in international markets through central bank interventions at that time.
Such interventions of competitive lowering of currency values using monetary and exchange rate instruments was termed “international currency wars”.
How was this currency trend resolved?
Unilateral competitive actions by countries was hindering the effective recovery of the global economy and deepening the trouble.
Considering the enormity of the issue, US had called for a summit of top 20 economies (G20) for the 1st time, which met at Washington DC.
India, the 13th largest economy then, was a member of the G20, and the grouping accounted for almost four-fifths of the world economy.
The single most important decision by the summit leaders in DC was to coordinate efforts and strive for a broad revival of the global economy.
In this context, competitive actions to keep currency values low was decried as a malpractice in international trade.
Why has the talk of currency war revived again?
Trade War - Global trade skirmishes have intensified lately with the US President Trump threatening to slap comprehensive tariffs on Chinese goods.
While tariffs have made Chinese goods costly in the U.S., the recent depreciation of Chinese yuan (almost 8% against USD) has partly offset this.
While this is largely due to slower growth in the Chinese economy, it has frustrated Trump, who is mulling more tariffs to contain China.
Similarly, trade tensions between the US and Europe too has escalated after both imposed tariffs on each other after Trump started the chaos.
Protectionism - Trade tensions may tempt counties to use monetary policy instruments to competitively devalue their currencies as a counter to tariffs.
This may lead to further chaos and worsen the overall scenario that would already be marred with disrupted supply chains.
Such actions might spell doom for all economies and make the whole world poorer by a considerable margin.
What is scenario in India?
Local Metrics - In the last 10 years, the Indian economy has grown rapidly, rising from being the 13th largest in 2008 to the 6th largest in 2018.
However, the rising crude oil prices has been pressuring India’s balance sheets immensely, leading to large “balance of payment” deficits.
This is might trigger a macro economic crisis and also lead to flight of foreign and local capital elsewhere, thereby ushering in a self fuelling prophecy.
Further, this will adversely impact inflation, interest rates and currency value (Indian rupee has already depreciated 6.8% against the dollar since Jan 2018).
RBI recently tightened the money flow by increasing the interest rates further, which might help in curtailing inflation and stemming the outflow of capital.
International Metrics - India has been increasingly getting integrated more with global markets over the years.
Hence, an upswing in the world economy is likely benefit India too.
An international currency war due to heightened tariff tensions can hurt the global economy, and in the process hurt India’s growth prospects too.
