With the European central bank joining in with its own version of monetary stimulus in early September, there is now barely a country in the world that isn?t relying on a weak currency to shift the terms of trade in its favour. This isn?t a good portend for India, where growth prospects rest critically upon sustained exports at a point when domestic demand is weak. Exports alone added 2.8 percentage points to the 5.8% GDP growth at market prices in April-June quarter, accounting for 48% of it. While August?s 2.4% export growth might be a temporary blip, the fact that overall exports grew just 8.5% in 2013-14 from 6% in 2012-13 despite a heavily depreciated rupee merits attention. So does the fundamental reality of a changed global trade dynamics after the crisis: The OECD notes the moderate pace of global trade persists while trade-intensive investment remains subdued, reflecting in a sub-par growth of global trade in goods and services; since 2011, this is nearly half the long-term (1990-2007) pre-crisis average growth of global trade.
Besides lowered levels of external demand, which appears waning yet again with major importers slowing or even contracting, Indian policymakers have to reckon with depreciating foreign currencies as well. That erodes whatever competitiveness India gained from the rupee?s sharp depreciation last year. While an uncertain external scenario remains, well, uncertain, the shifts in relative prices or currency depreciations are there to stay. How to survive the currency war in today?s world is a matter of urgent policy attention, therefore.
Along with the rupee, other emerging market currencies such as the Brazilian real, Indonesian rupiah, Turkish lira, etc, also depreciated last year. Although most EM currencies including the rupee, rebounded somewhat, they still retain significantly lowered values. With its large inflation differentials, India gained in external competitiveness as observed for example, in the performance of information technology or textile exports that operate on low margins and high volumes.
However, the global currency environment seems to be taking another, sharper turn. The European Central Bank, which recently slashed its deposit and refinancing rates (by 10bps) and announced a monetary stimulus program, intends to weaken the euro, amongst other objectives. This would boost the euro zone?s stagnating exports and offset its deflationary pressures. With an export share of 15.3% in total world merchandise exports (excluding intra-EU trade) as per the WTO, the Euro area?s major destinations are the United States (13% of total exports) and United Kingdom (12%). In its September macroeconomic assessment, the ECB expects the area?s export benefits will be enhanced by the effects of the weaker effective exchange, helped by a gradual global recovery.
China is almost on par with a 14.7% share in global merchandise trade. Pressures from faltering industrial output?at 6.9% year-on-year in August, this was the slowest pace of expansion since the global financial crisis?and slowing overseas demand pose a serious threat to its 7.5% economic growth target for 2014. Although the Chinese authorities are currently allowing the yuan to fluctuate against other currencies, they had earlier allowed 1.5% depreciation against the dollar in January-March. Compulsions to further relax monetary policy to arrest the output deceleration, buttressed by declining electricity production, car sales, property sales volumes, fixed assets growth and so on, are quite obvious. According to latest media reports, the People?s Bank of China is injecting a combined 500 billion yuan ($81.35 billion) of liquidity into the country?s top banks, a sign of the stepped-up efforts to prop up a slowing economy.
Japan has been in the depreciate-the-currency-league war from early last year, when the Bank of Japan launched its aggressive monetary easing aimed at a 2% inflation target. Its 7% contraction in April-June quarter has raised expectations of further monetary stimulus. Although its central bank refrained from such exercise at its early September meeting, the fact short-term interest rates were driven below zero by the Bank of Japan?s purchases of three-month bills last week betrays renewed efforts to stoke inflation via weakening the yen.
That leaves the dollar, which is rapidly gaining strength on the back of its recovering economy. Last week was the ninth successive week of its rise, according to Reuters. Since all other currencies in the world will depreciate likewise against the dollar, India doesn?t gain anything from that. The only countries that benefit are the ones explicitly driving down their currencies. The threat to exports couldn?t be starker. If every other country is bidding to export its way to growth, respective import demand then constitutes another drag upon export growth in the forthcoming times.
In April this year, the WTO projected developed countries? imports to grow at 3.4% in 2014 and 3.9% in 2015; as an offside, this compares with their 10.6% import growth in 2010. The OECD calculated that imports by its 35-member group remain 11% below their two-decade long, pre-crisis trend.
The implications for India are important. If exports are impacted by a global environment of low, below-trend demand and depreciating exchange rates of the major demand-source countries, it could restrict the economy in a low-growth trap. Slower trade distorted by relative price shifts means lesser export earnings, or foreign currency inflows on the current account side. This limits importing requirements, given the need to reduce dependency upon short-term capital account borrowings financing. The constraint of a sustainable current account dynamics then binds the economy into lower investment-consumption or low-growth levels. Domestically too, the fiscal constraint is binding until 2017.
The current global environment underlines the urgency of preventing such a slide. The way to do that is impart fresh impulses of competitiveness from other sources, viz. sustained productivity enhancements through structural reforms. While in the long-run this implies increasing the productivity of all factor inputs, reforms in the short to medium-term could focus upon deregulation of some product markets to increase competition and efficiency. The importance cannot be overemphasised, if only to survive the currency war.
The author is a New Delhi-based macroeconomist