INTERNATIONAL CURRENCY WAR: WHY INDIA SHOULD DEPRECIATE IT'S CURRENCY IN LONG TERM?( By S.Ramamoorthy)
We Indians always complain about the depreciation of Indian Rupee against USD assuming that Rupee Appreciation is directly related to the strength of our economy and to our pride. But most of the nations in the world are desperately trying to devalue their currency through money printing just to make their export very competitive. Our currency value against USD is Rs 61/- which we feel that very low...
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But here are some statistics........
1. Value of one Japanls (World's Third Largest & developed economy) Yen Against US dollar: 101 Yen
2. Value of one South Korea;s ( Developed Country) Won against 1 US dollar: 1032 Won
3. Value of one Indonesian Rupiah against 1 US Dollar: 11789 Rupiahs
4. Value of one China's Yuan ( World's Second Largest Economy ) against USD: 6.16
The above major economies are well developed and Major exporting economies in the world which are artificially keeping their currency value low against US dollar by printing paper money just to make their exports very competitive. Still they are very strong..Inflation is under control.
SO IF DEPRECIATION OF RUPEE IS GOOD, WHY WE COMPLAIN?....Let us discuss in detail
QUESTIONS ARE AS FOLLOWS
A. How International Currency Market is working?
B.What are India's Problem? and Why India should depreciate our currency in long term?
C. What will be the consequences of International Currency War?
A. HOW CURRENCY MARKET WORKS? WHO DETERMINES THE VALUE OF OUR CURRENCY?
In a free market Capitalism, price of anything in the market is being determined by the supply and demand mismatch. So in the currency market also, value of any currency will be determined by the supply & demand of the dollar against local currency i.e difference between Import & Exports of that economy. If a country imports more than what it exports, demand for dollar will increase since dollar is defacto reserve currency and all imports should be paid in dollar. In case of India, we are net importer country ( our total import in June 2014 was $ 38 Billion USD and Export is mere $ 27 Billion).
In international monetary term, it is being called us "Current Account Deficit" or CAD ( Difference between Bill paid for imports and Revenue earned on exports). So when a country becomes net exporter, it earns revenue and vice versa.
Any country should aim for lower import since import is nothing but expenditure from pocket where export is income...
So Let us see How it affects the Exchange rate of currency?
They are two type of exchange rate control system. One is fixed exchange control system / managed exchange rate system in which government will permanently fix / manage the exchange rate of their currency against dollar which India, china, japan follows and another system is floating exchange rate system in which market pressure will determine the value of the exchange rate where government plays no role at all.
Advantage of Floating exchange rate system is that Market Factors will depreciate the value of currency if country becomes net importer and appreciate the value of currency if country becomes net exporter whereas in the managed exchange rate system, if value of currency depreciates, central bank will sell dollars from their foreign exchange reserves to arrest it fall and will buy dollars from market by printing local currency in case of appreciation of currency against dollar. This process is called Balance of Payment.
Let us see what is Balance of Payment. Before that there is another one fancy terms called as Capital Account which includes the following
1. Foreign Investments including FDI ( Foreign Direct Investment & FII ( Foreign Institutional Investment and Portfolio investment)
2. Loans ( External Commercial Borrowing (ECB), Loan received from other countries)
3. Bank Capital ( Net foreign assets and Liability of Banks & NRI Investments)
Balance of Payment = Current Account ( Revenue from Export - Revenue from import ) + Capital Account ( FDI flows + Loans +Bank Capital) .
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If a country follows floating exchange systems, then no need to worry about balance of payment because market pressure will keep Balance of payment always Zero by adjusting the exchange rate. In the managed exchange system which India follows, it is the central Banks job to maintain zero Balance of Payment since it wont allow market factor to decide the value of currency.
In Case of Net Importing countries which follows Managed Exchange Rate System like India:
In these countries, market pressure will try to depreciate the currencies of these countries since import is high which will increase the demand for dollars. But since these countries are not allowing rupee to depreciate for unknown reasons following will be the impact.
As long as capital account surplus (Net FDI, FII , ECB, NRI Deposit came into India in last year is around $ 100 billion ) matches the current account deficit ( Bill paid for Import - Revenue from export which is around $100 billion in last year), there is no problem. But in the case of financial crisis, capital flows will start to flee from the economy as happened in 2009( only $ 6.8 Billion net inflow against $100 Billion now) by depreciating the currency value & increasing the dollar demand...So to stop the currency fall, central bank should be forced to the sell dollars from the foreign exchange reserves ( India current foreign exchange reserve is $320 billion). Once foreign exchange reserves got over, India will be in serious trouble as happened in 1991 Economic Crisis of India when India forced to pledge 67 MT of gold to International Monetary Fund. 1997 financial crisis of south east asian nations also teaches us the same.
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Now another interesting question is that why USA which is net importer country like india is not being affected by Dollar Depreciation? Why case of USA is different from others?
Answer is obvious. Dollar is defacto reserve currency of the world. 65 % of the world's Surplus money ( $ 6.8 Trillion ) is being kept in dollars. It is being seen as safe heaven in case of financial crisis. World has no other choice than to depend on Dollars. This is the reason why value of dollar got appreciated in 2008 financial crisis even though culprit was the failure of American Financial System.We call it as Triffen Dillema.
In case of Net exporting countries which follows Managed Exchange Rate System like china, Japan:
In these countries, market pressure will try to appreciate the currencies of this countries since export is high which will decrease the demand for dollars. But these countries are not allowing rupee to appreciate for the following reasons
1. Rupee appreciation will erode the competitive advantage of their export.
2. Reduction in exports will kill the employment as exactly happened in 2008.
3. Redction in exports and unemployment will reduce the GDP resulting in social unrest
So these countries wont allow their currencies to appreciate against USD by artificially creating the demand for Dollars through newly printed local currencies ( money printing)......THIS IS CALLED CURRENCY WAR... All these countries are printing new money every year just to depreciate their currencies artificially inorder to increase their exports.
B.WHAT ARE THE INDIA'S PROBLEM ? WHY SHOULD INDIA DEPRECIATE THE CURRENCY IN LONG TERM?
Let us see the How exchange rate will affect our day to day lives
For example, if value of indian currency falls from Rs 61 to Rs 100, it is the good news for export sector like Software, Textiles since they will be paid in dollar from their client and their rupee realization of that dollar will be huge for same work. So there will be boom for export sector which will create the employment as happened in software boom of south India(India's sofware export is just $120 billion but it creates 50 lakhs direct and indirect jobs). At the same time it will increase the cost of imported items like petroleum, gold & coal resulting in inflation.
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So Export means Income and Job Creation and Import means expenditure and erode of saving. India's problem is that it is net importer country. As long as it is net importing country,net advantage of rupee depreciation is null. So India should try to reduce it's imports and starve to become net exporter country in long term..But question is How?
India's Major exports are Oil ( around $ 125 billion in current FY), Gold ( around $30 billion) Coal & Machineries.
Import of Coal:
Worst Part is that india is having world's second largest coal reserve. Still, it is importing coal since Public sector Coal India is not able to mine more to meet the local demand.Real solution is to open coal mining to private players which will create local employment and even exports instead of imports.
Import of oil:
India imports 70% of oil from other countries even though it has sufficient reserves locally. What is needed is that opening the sector for private players and FDI. Technologies from FDI and Competition will ensure the local oil production in india by creating job and reducing the dependence on imports.
SO INDIA SHOULD SHOULD TRY TO BECOME NET EXPORT COUNTRY VERY SOON WITH BENEFIT FROM DEPRECIATION OF CURRENCY
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C. WHAT WILL BE THE CONSEQUENCES OF CURRENCY WAR?
We have seen so far that How countries are artificially keeping their currency value low against USD by printing money. What will be the consequences of this?
1, This newly printed fiat currency will create the asset bubbles in the world economy and will one day result in uncontrolled inflation.
2. It will encourage the carry trade ( where this money will find it's way to emerging economics like india where interest rate is very high) which will further increase the risk of financial system.
3, This new money will increase the volatility of Stock Market and Crash as predicted by Mr.Raguram rajan in his recent interview.
We Indians always complain about the depreciation of Indian Rupee against USD assuming that Rupee Appreciation is directly related to the strength of our economy and to our pride. But most of the nations in the world are desperately trying to devalue their currency through money printing just to make their export very competitive. Our currency value against USD is Rs 61/- which we feel that very low...
But here are some statistics........
1. Value of one Japanls (World's Third Largest & developed economy) Yen Against US dollar: 101 Yen
2. Value of one South Korea;s ( Developed Country) Won against 1 US dollar: 1032 Won
3. Value of one Indonesian Rupiah against 1 US Dollar: 11789 Rupiahs
4. Value of one China's Yuan ( World's Second Largest Economy ) against USD: 6.16
The above major economies are well developed and Major exporting economies in the world which are artificially keeping their currency value low against US dollar by printing paper money just to make their exports very competitive. Still they are very strong..Inflation is under control.
SO IF DEPRECIATION OF RUPEE IS GOOD, WHY WE COMPLAIN?....Let us discuss in detail
QUESTIONS ARE AS FOLLOWS
A. How International Currency Market is working?
B.What are India's Problem? and Why India should depreciate our currency in long term?
C. What will be the consequences of International Currency War?
A. HOW CURRENCY MARKET WORKS? WHO DETERMINES THE VALUE OF OUR CURRENCY?
In a free market Capitalism, price of anything in the market is being determined by the supply and demand mismatch. So in the currency market also, value of any currency will be determined by the supply & demand of the dollar against local currency i.e difference between Import & Exports of that economy. If a country imports more than what it exports, demand for dollar will increase since dollar is defacto reserve currency and all imports should be paid in dollar. In case of India, we are net importer country ( our total import in June 2014 was $ 38 Billion USD and Export is mere $ 27 Billion).
In international monetary term, it is being called us "Current Account Deficit" or CAD ( Difference between Bill paid for imports and Revenue earned on exports). So when a country becomes net exporter, it earns revenue and vice versa.
Any country should aim for lower import since import is nothing but expenditure from pocket where export is income...
So Let us see How it affects the Exchange rate of currency?
They are two type of exchange rate control system. One is fixed exchange control system / managed exchange rate system in which government will permanently fix / manage the exchange rate of their currency against dollar which India, china, japan follows and another system is floating exchange rate system in which market pressure will determine the value of the exchange rate where government plays no role at all.
Advantage of Floating exchange rate system is that Market Factors will depreciate the value of currency if country becomes net importer and appreciate the value of currency if country becomes net exporter whereas in the managed exchange rate system, if value of currency depreciates, central bank will sell dollars from their foreign exchange reserves to arrest it fall and will buy dollars from market by printing local currency in case of appreciation of currency against dollar. This process is called Balance of Payment.
Let us see what is Balance of Payment. Before that there is another one fancy terms called as Capital Account which includes the following
1. Foreign Investments including FDI ( Foreign Direct Investment & FII ( Foreign Institutional Investment and Portfolio investment)
2. Loans ( External Commercial Borrowing (ECB), Loan received from other countries)
3. Bank Capital ( Net foreign assets and Liability of Banks & NRI Investments)
Balance of Payment = Current Account ( Revenue from Export - Revenue from import ) + Capital Account ( FDI flows + Loans +Bank Capital) .
If a country follows floating exchange systems, then no need to worry about balance of payment because market pressure will keep Balance of payment always Zero by adjusting the exchange rate. In the managed exchange system which India follows, it is the central Banks job to maintain zero Balance of Payment since it wont allow market factor to decide the value of currency.
In Case of Net Importing countries which follows Managed Exchange Rate System like India:
In these countries, market pressure will try to depreciate the currencies of these countries since import is high which will increase the demand for dollars. But since these countries are not allowing rupee to depreciate for unknown reasons following will be the impact.
As long as capital account surplus (Net FDI, FII , ECB, NRI Deposit came into India in last year is around $ 100 billion ) matches the current account deficit ( Bill paid for Import - Revenue from export which is around $100 billion in last year), there is no problem. But in the case of financial crisis, capital flows will start to flee from the economy as happened in 2009( only $ 6.8 Billion net inflow against $100 Billion now) by depreciating the currency value & increasing the dollar demand...So to stop the currency fall, central bank should be forced to the sell dollars from the foreign exchange reserves ( India current foreign exchange reserve is $320 billion). Once foreign exchange reserves got over, India will be in serious trouble as happened in 1991 Economic Crisis of India when India forced to pledge 67 MT of gold to International Monetary Fund. 1997 financial crisis of south east asian nations also teaches us the same.
Now another interesting question is that why USA which is net importer country like india is not being affected by Dollar Depreciation? Why case of USA is different from others?
Answer is obvious. Dollar is defacto reserve currency of the world. 65 % of the world's Surplus money ( $ 6.8 Trillion ) is being kept in dollars. It is being seen as safe heaven in case of financial crisis. World has no other choice than to depend on Dollars. This is the reason why value of dollar got appreciated in 2008 financial crisis even though culprit was the failure of American Financial System.We call it as Triffen Dillema.
In case of Net exporting countries which follows Managed Exchange Rate System like china, Japan:
In these countries, market pressure will try to appreciate the currencies of this countries since export is high which will decrease the demand for dollars. But these countries are not allowing rupee to appreciate for the following reasons
1. Rupee appreciation will erode the competitive advantage of their export.
2. Reduction in exports will kill the employment as exactly happened in 2008.
3. Redction in exports and unemployment will reduce the GDP resulting in social unrest
So these countries wont allow their currencies to appreciate against USD by artificially creating the demand for Dollars through newly printed local currencies ( money printing)......THIS IS CALLED CURRENCY WAR... All these countries are printing new money every year just to depreciate their currencies artificially inorder to increase their exports.
B.WHAT ARE THE INDIA'S PROBLEM ? WHY SHOULD INDIA DEPRECIATE THE CURRENCY IN LONG TERM?
Let us see the How exchange rate will affect our day to day lives
For example, if value of indian currency falls from Rs 61 to Rs 100, it is the good news for export sector like Software, Textiles since they will be paid in dollar from their client and their rupee realization of that dollar will be huge for same work. So there will be boom for export sector which will create the employment as happened in software boom of south India(India's sofware export is just $120 billion but it creates 50 lakhs direct and indirect jobs). At the same time it will increase the cost of imported items like petroleum, gold & coal resulting in inflation.
So Export means Income and Job Creation and Import means expenditure and erode of saving. India's problem is that it is net importer country. As long as it is net importing country,net advantage of rupee depreciation is null. So India should try to reduce it's imports and starve to become net exporter country in long term..But question is How?
India's Major exports are Oil ( around $ 125 billion in current FY), Gold ( around $30 billion) Coal & Machineries.
Import of Coal:
Worst Part is that india is having world's second largest coal reserve. Still, it is importing coal since Public sector Coal India is not able to mine more to meet the local demand.Real solution is to open coal mining to private players which will create local employment and even exports instead of imports.
Import of oil:
India imports 70% of oil from other countries even though it has sufficient reserves locally. What is needed is that opening the sector for private players and FDI. Technologies from FDI and Competition will ensure the local oil production in india by creating job and reducing the dependence on imports.
SO INDIA SHOULD SHOULD TRY TO BECOME NET EXPORT COUNTRY VERY SOON WITH BENEFIT FROM DEPRECIATION OF CURRENCY
C. WHAT WILL BE THE CONSEQUENCES OF CURRENCY WAR?
We have seen so far that How countries are artificially keeping their currency value low against USD by printing money. What will be the consequences of this?
1, This newly printed fiat currency will create the asset bubbles in the world economy and will one day result in uncontrolled inflation.
2. It will encourage the carry trade ( where this money will find it's way to emerging economics like india where interest rate is very high) which will further increase the risk of financial system.
3, This new money will increase the volatility of Stock Market and Crash as predicted by Mr.Raguram rajan in his recent interview.
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