Escolar Documentos
Profissional Documentos
Cultura Documentos
PROJECT 2010-2012
SUBMITTED BY:
Smruti Gupta – 86
Sonam Daryanani –87
Sonam Gosalia 88
Soumitra Raut -89
Sowmya Charita 90
PAGE
SERIAL NUMBER TOPIC
NUMBER
Introduction 3-7
• Definition of Currency War 3
• Reasons for Currency War 3
1. • Why do Countries Want a Weaker Currency? 4
• How Does An Economy Weaken Its Currency? 4
• Benefits of Devaluation 5
• Seoul Summit 6
Foreign Exchange Rate 8-13
• Meaning and Types 8
2.
• Fluctuations in Exchange Rates 9
• Factors that Influence Exchange Rates 11
Competitive Devaluation: A Threat to Global Economy 14-24
(Major Countries) 15
• China
17
3. • US
19
• USA-China Economic Relations
22
• Japan
• European Union 24
Currency Wars and the Emerging Economies 25-29
• Impact on Emerging Economies 25
4.
• QE and the trilemma for emerging economies 25
• National Policy Developments in some Countries 28
Impact on India 30-32
5. • What should be done 31
• India’s Take On Currency War 31
6. Conclusion 33
7. Bibliography 34
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INTRODUCTION
Page | 3
The current situation is far from a war, although there is more conflict between nations' monetary
policies. The Western media's hyping of a "currency war" has exaggerated divisions on currency policies
and brought more tension to the international community.
Over the past decade, the world has been divided into "deficit" countries and "surplus" countries. Deficit
countries - US, UK, Greece & Spain
Surplus countries - China, Japan & Germany
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• Print money / Quantitative Easing -
Increasing the supply of money, increases the supply of dollars (or Pounds). This leads to a fall in
the value of the dollar (Pound)
• Intervention Buying -
By purchasing the assets of other countries, you increase the value of their currency. For example, if
China uses its foreign currency to buy US Treasuries. It increases demand for the dollar and
therefore the dollar becomes weaker compared to the Yuan.
For example, the US Federal Reserve is pursuing quantitative easing. Japan has been recently been
selling Yen and buying US assets. China has long been accused of currency manipulation
BENEFITS OF DEVALUATION
• Economic Growth -
If the dollar becomes weaker, exports become cheaper leading to an increase in demand for US
exports. This can help to increase AD and improve the rate of economic growth. This may be
important, because problems in the US housing market are threatening the rate of economic growth.
Falling house prices are potentially reducing consumer spending, therefore, a rise in exports could
help to boost economic growth and prevent any move towards a recession.
• Balance of Payments -
The US has a large current account deficit (7% of GDP) therefore a devaluation will help to improve
and reduce the current account deficit. However, a devaluation alone is unlikely to solve the
problem. Also, there is evidence that demand for exports and imports is relatively inelastic;
therefore, any devaluation will have a small impact on the value of exports and imports. It is argued
that the fundamental reason for a deficit is the low levels of domestic savings and consequently high
levels of consumer spending.
• Inflation -
A devaluation may lead to increased inflationary pressures for 3 reasons:
§ Increase in exports causes rising AD and therefore could lead to demand pull inflation
§ Imported goods will be more expensive. American consumers would definitely experience a
rise in price for many imported manufactured goods and imports of raw materials could
increase costs of business
§ It is argued a devaluation reduces the incentive, for manufacturers and exporters, to cut costs
and become more efficient
However, the impact of devaluation depends on the state of the economy. As previously mentioned, the
US economy is slowing down; therefore inflationary pressures are subdued and therefore inflation is
unlikely to occur.
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SEOUL SUMMIT
G20 Summit: Seoul Grounds for Currency Wars and Global Growth Pledges
The G20 summit was termed as a G2 summit by Prime Minister of United Kingdom, because it mainly
emphasized on the currency war between China and USA.
Leaders had gathered in Seoul for the fifth G20 summit where the market was to assess the comments and
the communiqué with crucial scrutiny amid the cold currency war.
The negotiators were taking crucial steps regarding financial safety and development issues; they did not
succeed in reaching an agreement over narrowing exchange rate differences or setting a benchmark as a
percentage of GDP for current account surpluses or deficits. (The 4% of GDP suggested last month by
Timothy Geithner that was rejected by Germany and China)
World Bank President Robert Zoellick said “Gold has become a reference point because holders of
money see weak or uncertain growth prospects in all currencies other than the Yuan, and the Yuan is not
free for exchange.
The US is the biggest lobbyist for the cause and pressures China to speed its currency revaluation as the
Yuan provide a very competitive advantage on export basis and surely it being the nation with the biggest
dollar reserve.
The US has been calling on China for years now and continues to fight as China takes little action and
now confronted with new pressures of HOT DOLLARS! The Feds are pumping extra cash into the
market with the newly introduced $600 billion asset purchase fund and the money is surely pouring into
China which continues to fear raging inflation and asset bubble formations.
The US wants more action from China and the Chinese are against any “shock therapy” to revaluate their
currency.
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G20 Leaders Agreement on Currency Deal in Seoul
Representatives from the 20 developed and emerging countries in Seoul agreed on "indicative guidelines"
to prevent tensions escalating into currency wars and the need to avoid protectionism.
At the end of the summit, the world's top industrialised nations said they would stop devaluing their
currencies to gain a competitive advantage over rival economies.
The US and Britain have accused China of keeping the value of its Yuan currency artificially low to make
its exports cheap, fuelling the massive trade imbalances which played a part in the global economic crisis
of 2008.The final communiqué also agreed to a move towards a more open system of international
exchange rates.
• Advanced deficit countries to follow policies of fiscal consolidation consistent with their
individual circumstances, also stating that fiscal correction need not be frontloaded everywhere.
• Structural reforms which are necessary should be done in a manner to expand the internal demand
in surplus countries. "While structural reforms are necessary everywhere, these should increase
efficiency and competitiveness in deficit countries, while expanding internal demand in surplus
countries. This re-balancing will take time, but it must begin," Singh said.
Although India advocated the case for exchange rate flexibility, it did not support the US line of putting a
cap on current account balance, proposed at four per cent of the Gross Domestic Product (GDP).
India's argument has been that it may not be easy to reach agreement on sustainable current account
balances for individual countries given the structural differences of economies.
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FOREIGN EXCHANGE RATE
In finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate) between
two currencies specify how much one currency is worth in
terms of the other. It is the value of a foreign nation’s
currency in terms of the home nation’s currency.
For example an exchange rate of 91 Japanese yen (JPY, ¥)
to the United States dollar (USD, $) means that JPY 91 is
worth the same as USD 1.
The foreign exchange market is one of the largest markets
in the world. By some estimates, about 3.2 trillion USD
worth of currency changes hands every day.
The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an
exchange rate that is quoted and traded today but for delivery and payment on a specific future date.
Quotations:
An exchange system quotation is given by stating the number of units of "quote currency" (payment
currency) that can be exchanged for one unit of "base currency" (transaction currency). For example, in a
quotation that says the EUR/USD exchange rate is 1.2290 the quote currency is USD and the base
currency is EUR
There are two types of Quotations -
In direct quotation, if the home currency is strengthening (i.e., appreciating, or becoming more valuable)
then the exchange rate number decreases. Conversely if the foreign currency is strengthening, the
exchange rate number increases and the home currency is depreciating.
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Different Countries Follow Different Exchange Rate Systems:
FIXED FLOATING
FIXED PEGGED INDEPENDENT MANAGED
China United States of America India
Egypt U.K Malaysia
Euro Zone
Pakistan Brazil Sri Lanka
(Euro countries)
Nepal Japan
Mauritius
Iraq South Africa
Free or Pegged:
If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is
determined by the market forces of supply and demand. Exchange rates for such currencies are likely to
change almost constantly as quoted on financial markets, mainly by banks, around the world. A movable
or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a
currency. For example, between 1994 and 2005, the Chinese Yuan (RMB) was pegged to the United
States dollar at RMB 8.2768 to $1. China was not the only country to do this; from the end of World War
II until 1967, Western European countries all maintained fixed exchange rates with the US dollar based
on the Bretton Woods system.
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Uncovered Interest Rate Parity:
Uncovered interest rate parity (UIRP) states that an appreciation or depreciation of one currency against
another currency might be neutralized by a change in the interest rate differential. If US interest rates
increase while Japanese interest rates remain unchanged then the US dollar should depreciate against the
Japanese yen by an amount that prevents arbitrage (in reality the opposite (appreciation) quite frequently
happens, as explained below). The future exchange rate is reflected into the forward exchange rate stated
today. In our example, the forward exchange rate of the dollar is said to be at a discount because it buys
fewer Japanese yen in the forward rate than it does in the spot rate. The yen is said to be at a premium.
Page | 10
A market based exchange rate will change whenever the values of either of the two component currencies
change. A currency will tend to become more valuable whenever demand for it is greater than the
available supply. It will become less valuable whenever demand is less than available supply (this does
not mean people no longer want money, it just means they prefer holding their wealth in some other form,
possibly another currency).
Increased demand for a currency is due to either an increased transaction demand for money, or an
increased speculative demand for money. The transaction demand for money is highly correlated to the
country's level of business activity, gross domestic product (GDP), and employment levels. The more
people there are unemployed, the less the public as a whole will spend on goods and services. Central
banks typically have little difficulty adjusting the available money supply to accommodate changes in the
demand for money due to business transactions.
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1. Differentials in Inflation -
As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its
purchasing power increases relative to other currencies. During the last half of the twentieth century, the
countries with low inflation included Japan, Germany and Switzerland, while the U.S. and Canada
achieved low inflation only later. Those countries with higher inflation typically see depreciation in their
currency in relation to the currencies of their trading partners. This is also usually accompanied by higher
interest rates.
3. Current-Account Deficits -
The current account is the balance of trade between a country and its trading partners, reflecting all
payments between countries for goods, services, interest and dividends. A deficit in the current account
shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital
from foreign sources to make up the deficit. In other words, the country requires more foreign currency
than it receives through sales of exports, and it supplies more of its own currency than foreigners demand
for its products. The excess demand for foreign currency lowers the country's exchange rate until
domestic goods and services are cheap enough for foreigners, and foreign assets are too expensive to
generate sales for domestic interests.
4. Public Debt -
Countries will engage in large-scale deficit financing to pay for public sector projects and governmental
funding. While such activity stimulates the domestic economy, nations with large public deficits and
debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if
inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future.
In the worst case scenario, a government may print money to pay part of a large debt, but increasing the
money supply inevitably causes inflation. Moreover, if a government is not able to service its deficit
through domestic means (selling domestic bonds, increasing the money supply), then it must increase the
Page | 12
supply of securities for sale to foreigners, thereby lowering their prices. Finally, a large debt may prove
worrisome to foreigners if they believe the country risks defaulting on its obligations. Foreigners will be
less willing to own securities denominated in that currency if the risk of default is great.
5. Terms of Trade -
A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the
balance of payments. If the price of a country's exports rises by a greater rate than that of its imports, its
terms of trade have favorably improved. Increasing terms of trade shows greater demand for the country's
exports. This, in turn, results in rising revenues from exports, which provides increased demand for the
country's currency (and an increase in the currency's value). If the price of exports rises by a smaller rate
than that of its imports, the currency's value will decrease in relation to its trading partners.
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COMPETITIVE DEVALUATION: THREAT TO GLOBAL ECONOMY
Page | 14
CHINESE CURRENCY MANIPULATION
The Chinese
ese government is being criticised for the ‘manipulation’ of their currency. They have been
keeping the Chinese currency undervalued to promote growth and exports. At the
moment China only pegs its currency against the dollar and not a wider basket of
currencies.
• A weaker exchange rate makes exports more competitive and increases demand for Chinese
exports.
• Chinese economic growth is dependent on exports, so the value of the currency pla
plays a key role
in boosting growth
• China needs high growth. China’s economic growth is remarkable high by global standards. But,
because of the switch from a state controlled industry to free market economy, there is still a
Page | 15
problem of unemployment. Growth in exporting manufacturing industries plays a key role in
creating jobs that are being lost in agriculture and other privatised state owned industries. With
little welfare support for the unemployed, the Chinese government are concerned about social
unrest should unemployment rise in the overcrowded cities.
• A weak currency creates inflationary pressure which means commodity prices are more
expensive. Since China is a big importer of commodities, a weaker exchange rate increases the
cost of living and the cost of raw materials. The Government has allowed an appreciation in the
exchange rate to help mitigate inflationary pressure.
• China is seeking to diversify away from dollar assets. To maintain a weak exchange rate, the
Chinese need to keep buying dollar assets. However, many are worried about holding so much
dollar assets given weakness of US economy. Therefore, China is seeking to diversify away from
US dollar, but, by doing this the exchange rate will appreciate.
§ Chinese exporters have greater incentive to cut costs and increase efficiency. This can benefit
the economy in the long run
This is important, because the Chinese economy is growing above 10% per annum. This could lead to
inflationary pressures. An appreciation will help to moderate growth; in particular reduce the investment
and borrowing boom, which results from low interest rates.
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4.5% and the US trade deficit is merely a reflection of the low US savings ratio (and high
consumer spending) if the deficit wasn't with China it would be with somebody else.
• Balance of Payments
The US has a large current account deficit (7% of GDP) therefore devaluation will help to
Page | 17
improve and reduce the current account deficit. However, devaluation alone is unlikely to solve
the problem. Also, there is evidence that demand for exports and imports is relatively inelastic;
therefore, any devaluation will have a small impact on the value of exports and imports. It is
argued that the fundamental reason for a deficit is the low levels of domestic savings and
consequently high levels of consumer spending.
• Inflation
Devaluation may lead to increased inflationary pressures for 3 reasons
o Increase in exports causes rising AD and therefore could lead to demand pull inflation.
o It is argued devaluation reduces the incentive, for manufacturers and exporters, to cut
costs and become more efficient.
However, the impact of devaluation depends on the state of the economy. As the US economy is slowing
down; therefore inflationary pressures are subdued and therefore inflation is unlikely to occur.
Page | 18
USA-CHINA ECONOMIC RELATIONS
The relationship between China and the USA is an intriguing example of how economic ties can bind in a
way that political ideology never could.
• USA exports to China account for 0.5 percent of USA GDP. In a trade war, there would be one
clear loser.
• Because of this large trade surplus China has substantial foreign currency reserves. With these
foreign currency reserves, China has accumulated $2 trillion in foreign reserves, mostly in
Treasury bonds (government debt) and other dollar-denominated assets
1. Buying USA bonds keeps the Chinese currency, the Yuan, undervalued. This makes Chinese
exports more competitive and helps boost Chinese growth.
2. The Chinese have so many USA assets they don't want to see them devalued. In a perverse way,
the Chinese have a vested interest in the value of the dollar. Also they need a strong USA
economy so USA consumers will keep buying its goods.
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USA Trade Deficit With China
USA’s trade deficit with China was $268 billion in 2008, an all-time high for a trade deficit with any
country. Explain some possible causes of a balance of trade deficit and consider if USA should be
concerned over its trade deficit with China.
1. Undervalued Yuan –
According to the Big Mac index compiled by the Economist, the Chinese Yuan is 49%
undervalued against the Dollar. This is partly because the Chinese Government seek to keep the
Yuan undervalued by restriction currency flows. The undervalued Yuan gives a competitive
advantage to Chinese exporters relative to US exporters.
Saving ratios mean that levels of consumption are higher in US. China’s high saving ratios mean
Page | 20
that consumer spending on imports is relatively lower. Instead China use their savings to invest
and purchase capital flows from abroad. (It is these capital flows which help to finance current
account deficit.)
• In manufactured goods, China has a clear comparative advantage; it’s greater competitiveness
has contributed to US deficit
Page | 21
doing this through increasing spending, thereby increasing the debt, and by keeping the Fed funds rate at
virtually zero, increasing credit and the money supply.
China is keeping its currency low by pegging it to the dollar, along with a basket of other currencies. It
keeps the peg by buying U.S. Treasuries, which limits the supply of dollars, thereby strengthening it. This
keeps the Yuan low by comparison.
Brazil and other emerging market countries are concerned because the currency wars are driving their
currencies higher, by comparison. This raises the prices of commodities, such as oil, copper and iron,
which are their primary exports. This ma
makes
kes emerging market countries less competitive, and slows their
economic growth.
In case of India currently we have a managed float. The central bank hardly intervenes in the currency
market and refuses to take a clear view on the currency levels. With the growth we are seeing in the
domestic market, a lot of hot money in the form of FII inflows is entering the country.
JAPAN
The yen lost most of its value during and after World War II. After a period of instability, in 1949, the
value of the yen was fixed at ¥360 per US$1 through a
United States plan, which was part of the BRETTON
Woods System, to stabilize prices in the Japanese
economy. That exchange rate was maintained until
1971, when the United States abandoned the gold
standard, which had been a key element of the
BRETTON Woods System, and imposed a 10 percent
surcharge on imports, setting in motion changes that eventually led to floating exchange rates in 1973.
By 1971 the yen had become undervalued. Japanese exports were costing too little in iinternational
nternational
markets, and imports from abroad were costing the Japanese too much. This undervaluation was reflected
in the current account balance, which had risen from the deficits of the early 1960s to a then
then-large surplus
of U.S. $5.8 billion in 1971. The
he belief that the yen, and several other major currencies, were undervalued
motivated the United States' actions in 1971.
Japanese Yen has been touching new historical highs in the year 2010 with Yen breaching 15
15-year high
record in September. This is likely
ely to impact the Japanese exporters which form a significant part of
Japanese economy. Recently, Bank of Japan (BOJ) intervened twice in the currency market which by
many analysts has been seen as signs of open currency war in the coming years. The atmosp
atmosphere has
Page | 22
become quiet tense in past few months and volatility is expected to be high in the currency market, which
is seen by many as a sign of dramatic change in the dominance of Greenback (US Dollar).
• Industrial production unexpectedly declined for a third month and gains in retail sales were
smaller than economists' forecast, government figures released last week showed. The overall
economy grew just 1.7% in the April- June period, compared to a 5% expansion in the first three
months of the year.
• Japan's economy will probably contract in the fourth quarter because the government's incentives
to subsidize energy efficient cars expired in September, and increased consumer spending due to
an unusually hot summer will wane.
Japan has a number of challenges that limit its ability to allow ongoing currency appreciation, including
an aging population, high public debt (though not net debt as it has high private savings) and vulnerability
to deflation. The September devaluation did not draw widespread international condemnation. Within a
couple of weeks upwards pressure on the Yen from the markets had almost entirely undone the effect of
the intervention.
By artificially devaluing the yen, Japan joins a chorus of countries entering what is now being called an
"international currency war."
Japan also has a large current account surplus, and in 2009 and 2010 the country allowed the Yen to
appreciate. However, in September 2010 Japan twice intervened to effect devaluation
Page | 23
EUROPEAN UNION
The euro zone officially the euro area is an economic and
monetary union (EMU) of 16 European Union (EU)
member states which have adopted the euro currency as
their sole legal tender. It currently consists of Austria,
Belgium, Cyprus, Finland, France, Germany, Greece,
Ireland, Italy, Luxembourg, Malta, the Netherlands,
Portugal, Slovakia, Slovenia and Spain not including
Sweden, which has a de facto opt out) other states are
obliged to join the zone once they fulfil the strict entry
criteria.
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CURRENCY WARS AND THE EMERGING-MARKET COUNTRIES
Page | 25
achieving their monetary policy objectives, unless they too are in a liquidity trap (of which more below).
And if they are, then expansion in the home country (escape from the liquidity trap) raises the world
natural rate of interest and hence alleviates the others’ liquidity traps.
Now move to a world of big countries, all at the zero bound. Ideally, all should inflate in a coordinated
fashion, so that exchange rates are not affected. Uncoordinated policies could bring currency volatility.
This destabilises markets, creates a highly uncertain environment for business, and raises pressures for
trade policy interventions. With simultaneous QE, there might not be first-order effects on the exchange
rates between the big countries. And simultaneous QE could achieve simultaneous expansion, which
would have first-order effects on the natural rate of interest, helping to restore more normal monetary
conditions.
Although simultaneous QE in all big economies might wash out in exchange rates, there are also many
small economies – including the emerging market countries. What happens in such a world? Some of the
additional liquidity in the economies at pursuing QE at the zero lower bound flows to countries with
higher interest rates. Their currencies appreciate, and expected appreciation attracts more capital flows.
(Yes, the carry trade is indeed profitable; uncovered interest parity is violated.) Global liquidity goes up,
foreign-exchange reserves rise in those smaller countries that intervene to try to resist appreciation. The
big economies are exporting bubbles. But global rebalancing should be achieved by raising consumption
in the rest of the world, rather than investment in financial assets and real estate.
Meanwhile, if one large economy does not participate (e.g., the Eurozone), then its currency will also
appreciate, with accompanying political and trade tensions. And volatility between exchange rates of
large countries is more harmful than if it is confined to small countries.
Here, it is vital to see that simultaneous QE is not the same as simultaneous exchange-rate intervention. In
the latter case, central banks will typically hold reserve increments in foreign short-run debt (as noted
above). If all do this, the net effect is that of domestic open-market operations in short-dated government
securities. At zero interest rates, these securities are perfectly substitutable for money. There is a liquidity
trap, so exchange-rate intervention at the zero lower bound achieves nothing – whereas QE does seem to
have an impact on both interest rates and exchange rates.
If the large developed market countries do more QE, however, then the flow of liquidity to the emerging
markets may force the latter to respond. They may try to resist exchange-rate appreciation by intervening
in the foreign exchange markets. Here we do have competitive devaluation i.e. the “currency wars”. And
if the emerging market countries do not sterilise the intervention, or if sterilisation is at least partly
ineffective, then they experience inflationary pressures. So capital inflow controls look tempting – but
Page | 26
experience suggests they may not be very effective, unless there is much broader financial repression
(e.g., China).
This is why we see statements like “The US will win this war: it will either inflate the rest of the world or
force their exchange rates up against the dollar”. But there is a potential downside for the US. Substantial
dollar depreciation will weaken the global position of the dollar, as it did in the late 1970s.
If fiscal consolidation does not raise confidence in the home economy, then other nations take a double hit
- a fall in activity in their home economies and exchange-rate appreciation against them so Exchange-rate
intervention – another question in the currency wars!
If US monetary policy eases further, it will get the exchange rate depreciation that it wants. It will indeed
win the currency wars. Conventional wisdom is wrong: The US can, after all, devalue the dollar. But
there are costs:
• More likely are capital account protectionism, in the form of emerging market capital controls;
• Damaging exchange-rate volatility, including among the large countries, if QE is not coordinated
(simultaneous).
Moreover, in the longer run, this could substantially weaken the hegemony of the dollar in the
international financial system. There is also the fear of a bubble, which will burst once developed
economies are back on track and the flow of capital shrinks. This shrinking is expected to be first
reflected in the currency markets.
Exchange-rate pressures, global imbalances and rebalancing, spillovers and the desirability of policy
coordination – these are at the centre of the economic interdependence between the developed and
emerging market countries. All this is in the context of weak US and European recoveries from the Great
Recession, the risk of deflation, and the likelihood of more quantitative easing (QE) by major central
banks. Domestic issues and inability to get direct action on exchange rates has led the US to propose
internationally agreed targets for current-account imbalances.
Policies such as these cannot be properly assessed without an analytic framework. In the current
discussion, the furthest this has gone is evocation of the “trilemma”: the impossibility of simultaneously
maintaining open capital markets, nominal exchange-rate stability, and monetary policy autonomy.
(“Inconsistent quartet”, which adds trade openness to these three – but protectionism, is indeed a potential
weapon in the currency wars, and we must not disregard that threat.)
While policymakers in both developed economies and emerging markets are aware of this trilemma, they
are not fully conscious of the international repercussions of QE by the largest economies when they are at
Page | 27
the zero lower bound for interest rates, while policymakers appear to grasp some of the issues, they
underestimate the impact of quantitative easing by large economies on exchange rates worldwide.
Page | 28
Brazil had a massive appreciation in 2009 and imposed a transactions tax on capital inflows, which has
just been raised, since the inflows have continued, intervention has accumulated large reserves, monetary
aggregates are rising rapidly, while inflationary pressures have led to interest rate increases.
Thailand has also imposed a tax on foreign holders of domestic securities, and Indonesia is considering
capital inflow controls. Singapore has widened its exchange-rate band. Countries from Israel to India and
South Africa are facing similar pressures: large short-term capital inflows, exchange-rate appreciation,
and inflationary risks.
In late June, China took steps to allow more movement in its currency, the Yuan, but the currency has
only appreciated about 2% vs. dollar since then.
Central banks that have already intervened to slow currency gains include those in Colombia, South
Korea, Peru and Taiwan. Further actual or verbal intervention efforts are likely to come from the Czech
Republic, Poland and South Africa. Israel, which was also on the list, has said it will continue buying
dollars to stem the rise of its shekel.
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IMPACT ON INDIA
Page | 30
What Should Be Done?
Some of the damage is irreparable. But looking ahead, the RBI should actively intervene in the forex
market to counter excess capital inflows and contain further real rupee appreciation (preferably roll back
some of the huge increase that has already occurred). Of course, the liquidity consequences of the forex
purchases should be sterilized through the standard techniques deployed so effectively in 2004-2007.
Second, we should deploy whatever tools for capital account management that are at hand to contain
surging flows. Third, the government should seriously consider levying temporary taxes of the kind
imposed by Brazil and Thailand. : (Brazil has doubled its tax (levied a few months ago) on debt inflows;
Thailand has announced a new 15 per cent withholding tax on bond purchases by foreigners; to moderate
their currency appreciation). Taiwan has placed restrictions on portfolio inflows; and several EMEs (and
Japan) have intervened in currency markets to moderate their currency appreciation).
The central bank (RBI) at such times tries to intervene — buy dollars and create an artificial demand for
the dollar, devaluing the value of the rupee in the process and retain some price advantage for the exporter
. But buying dollars involves a fiscal cost as the central bank has to pump in equivalent amount of rupees
and again mop it up by selling bonds. These bonds need to be serviced by the government. This would in
turn worsen the fiscal position.
Page | 31
Most Indian leaders see the case for sticking to the country’s open model. They do not want to impose
new capital controls, because they know that these leak and are a nightmare to administer. They are
reluctant to intervene against the rise of the currency, because they see that the best way to staunch
inflows of hot money may be to allow it to appreciate – at a certain point, investors will fear that the rupee
may reverse direction and hit them with losses.
Today’s eager interventionists should take note. Far more than they realize, they are setting up one-way
bets for traders. Hedge funds know that South Korea’s won is being artificially held down by the
government and is therefore more likely to rise than to depreciate, so they are hosing Seoul with capital
and compounding the problem of hot inflows that Korea is desperate to alleviate. If India’s leaders stick
to their open policies, and if the neo-interventionists meet their comeuppance, the current dirigisme may
prove mercifully short-lived.
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CONCLUSION
If China allows a floating rate on its currency i.e. allows the market forces to determine the value of Yuan
the price of its exports would increase considerably and thereby reduce demand for them. This is because,
as of the Chinese currency is highly undervalued. India being the next favorite for companies who are
currently importing from China is expected to benefit the most. The foreign currency earned from the
same shall greatly strengthen India`s position in the World Economy
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BIBLIOGRAPHY
1. www.imf.org
2. http://economictimes.indiatimes.com/markets/analysis/Currency-war-will-take-longer-to-sort-out-
feel-experts/articleshow/6963791.cms
3. http://economictimes.indiatimes.com/markets/forex/US-China-main-combatants-in-curency-
war/articleshow/6715385.cms
4. http://economictimes.indiatimes.com/articleshow/6911576.cms
5. http://www.bbc.co.uk/news/business-11608719
6. http://economictimes.indiatimes.com/markets/forex/ET-in-the-Classroom-Currency-
War/articleshow/6733299.cms
7. http://www.dailymail.co.uk/money/article-1319325/IMF-fails-deal-currency-
tensions.html?ito=feeds-newsxml
8. http://news.xinhuanet.com/english2010/world/2010-10/29/c_13582474.htm
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