US President Donald Trump's decision to impose sanctions on Iran and trade tariffs on imports from China and other countries has put the spotlight on currencies globally. There are already fears of trade wars escalating to currency wars among countries. There is a view that countries would retaliate with devaluation of currency to counter the trade tariffs imposed by US. The scenario is equally scary for India as the rupee has come under pressure as the global biggies fight it out. The rupee continued its free fall in early trade today and hit a fresh all-time low of 70.08 level to the dollar as Turkey's central bank struggled to contain a currency crisis that is feeding fears about other emerging markets.
China's likely devaluation
The US and China trade war will eventually see a currency war as the Chinese would play every trick in the book to protect its exports in the international market. In the past, the US had often accused China of keeping its currency artificially low to dump cheap goods in the global market. China is likely to resort to a gradual depreciation in its currency 'Yuan' against the US dollar. This will make Chinese goods more attractive in other countries. Indian exports, assuming the country will not participate in a currency war, will lose price advantage in many of the export markets. This will lead to widening of trade deficit and current account deficit.
Europe, Japan and other countries joining the currency war
It is likely that other countries will also join the currency war as they won't be a mute spectator to US-China trade and currency war. If that happens, Indian currency will have to adjust to the general depreciation of all the currencies.
Devaluation of currency is not the right tool for India
Devaluation of currency is not something advocated for India by experts. Former RBI governor Raghuram Rajan had earlier rejected the idea that devaluation of the Indian rupee would be the right tool to push exports into the world market. Rajan, a celebrated global economist, said that there is a need to improve productivity to remain competitive in the international market. And he also linked productivity gains to better infrastructure, improved human capital, removing administrative obstacles and ease of doing business etc. .
India's weak macros
Indian currency is already depreciating for the last six months. The higher current account deficit, rising US Fed rates and a slowdown in FII inflows into the Indian capital market is already weakening the Indian currency. The trade war would further increase the woes of the Indian economy.
Falling foreign exchange reserves
The Indian foreign exchange reserves are also declining for the last few months. The reserves have dropped from $425 billion to $405 billion. There is a clear indication that the RBI has been intervening in the market to protect the rupee value from depreciating. India has a different problem at hand. The rupee depreciation brings the threat of imported inflation. Crude prices have been on the rise. The US has already imposed sanctions on Iran which will be applicable to India from November onwards. This means India can no longer import oil from Iran. It has to look for other markets. These development will surely have a big impact on the rupee value.