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The Outbreak of Global Currency Wars

The developing economies will have to bear the onus of this round of global rebalancing

In the last part of his interview, Abheek Barua, chief economist, HDFC Bank, discusses how currency wars is a manifestation of a process of global rebalancing

Why has the current account deficit risen so high? Do you see this as a cause for concern? And is there any scope for reining it in?

I don't know if it makes sense to rein it in, if indeed we are looking at large flows of capital that will sustain. Then perhaps running a larger current account deficit is in our interest. But if we believe that these flows are fickle and will reverse, then financing the current account is a problem. Perhaps we should be prepared for that contingency.

The current account deficit is driven partly by oil prices. But the problem really has been very strong growth of non-oil imports which points to the fact that there has been a pickup in growth and that has been inducing a flow of imports. But the worrying bit, which we noticed in the last current account data, is that both IT and private transfers, which provide a buffer against large trade deficits, have slowed down substantially.

There is no magic bullet for controlling the current account deficit if indeed financing becomes a problem in future. But there are a few encouraging trends if you are looking at its financing. NRI deposits, which tend to be more or less stable, have picked up. These are capital account flows but would help in financing the current account. FDI (foreign direct investment) has been strong. Long-term commercial borrowings are back on the table. So it's wrong to say that the current account is being funded entirely through portfolio flows.

My final question is about the currency wars that we are hearing so much about. Why are we seeing this outbreak of currency wars now?

The currency war is a fallout of the Fed's decision. The US has re-entered stimulus mode. This will be administered largely through the monetary channel. It is likely to come through soon. The entire business of QE2 has changed the dynamics of currencies. Because of the assured supply of liquidity, there has been a massive over weighting of emerging markets, leading to an appreciation in their currencies. This is beginning to hurt a few countries, particularly Brazil, Thailand and so on.

This is one dimension. The other dimension is that there is a lot of pressure on China to revalue its currency. Again, if China revalues, there will be a spillover onto currencies of other emerging markets which will appreciate.

So the global currency war is really the first manifestation of a process of global rebalancing with the US now keen on becoming a more export-oriented economy and exporting its way out of the slowdown. That hurts emerging markets which want to protect their currencies from appreciating. This has led to the geo-political tensions of the last couple of months. I think this will get blown up. There will be a lot of sparring in various forums like G20.

Over the long term, emerging markets have to realise that the brunt of rebalancing in this round will have to be borne by them. They will have to face the pressure of capital flows if their growth rates exceed that of the developed world. There is a price to be paid for that. So their entire policy model will have to be reconsidered. In India's case, we will have to think of ways to make exports more competitive by enhancing productivity. That's how I see it.

In the short term, you will see a lot of cross flow of rhetoric from both sides. The issue is not going to go away in a hurry. The G20 meet promises to be quite acrimonious.

Will the US manage to force China to either revalue its currency upward or encourage more domestic consumption?

Both add up to the same thing. If China becomes more domestic consumption oriented then it doesn't have to depend excessively on exports. It can then make do with a more appreciated currency level.

Is it likely to happen?

China has actually done quite a bit. As regards domestic orientation, China has actually achieved quite a bit in the last three years. I think there are still risks going forward. The process is far from complete.

China has also allowed the Yuan to move within a band. It has actually moved up quite a bit, contrary to the perception that it's stuck in a groove. But I don't think that the kind of revaluation or appreciation that the US is talking about, which is 20 per cent in one shot - an actual revaluation rather than slow appreciation - is something that the Chinese authorities will agree to. And it would be actually quite dangerous for the economy.

China has an interesting point of view on the subject. The fact that China is exporting a lot to the US reflects structural changes in the global economic system wherein the US stopped producing certain things at a point in time because of the way its economy developed.

Consequently China got into those niches. That's a valid point. To expect China to do something dramatic or radical, as the US does, is being a bit too optimistic.

To read the previous parts of this interview follow the link

Part 1
Part 2