India needs to join the currency wars

Most large economies today have a structural problem. They are seeing declining growth rates,high unemployment,huge government debts and high fiscal deficits combined with an ageing workforce.

Most large economies today have a structural problem. They are seeing declining growth rates,high unemployment,huge government debts and high fiscal deficits combined with an ageing workforce. Governments have taken several steps to get growth back. They have kept interest rates low,announced huge fiscal stimulus programmes and taken control of certain institutions that could create systemic risks in their economies. All these steps have brought certain sanity and stability into the financial markets worldwide. However,they have had their own unintended side effects. The global liquidity boom is inflating all asset prices. Commodity prices are booming. Capital markets are at a one year high. Corporates are flush with cash but not investing. Overall,there is an artificial stability seen across the world,which lacks conviction and confidence.

US consumers are the biggest spenders in the world today. But they lack confidence in the environment and this is reflected in their saving rates. Their savings rate has gone up to 6% from being negative earlier. While China and India are doing well,consumers in these countries lack the spending power of US consumers. There is no country in the world that can replace the spending power of US consumers in the near term.

All the large economiesthe US,Europe and Japanneed to focus more on reducing fiscal deficit and government debt. They also need to focus on job creation as this is a large political issue. The only way to do this is to keep their currency competitive and export to the global markets. This will help job creation in their home country,reduce trade deficit and kick-start growth.

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However,when all the large economies want to do this at the same time,there is going to be some amount of friction. Japan has already taken the step to unilaterally intervene in the currency market to strengthen the Japanese yen. The US is sending strong messages to China to appreciate the renminbi. Whether the US will force China to revalue its currency as was the case with Japan in 1985 (through the Plaza Accord) is a moot point. Emerging economies may choose capital controls to counter their currency appreciation. Lastly,the currency wars could also end up with trade wars impacting all assets globally.

What does this mean for 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. Even though Indias trade deficit is very high ($13 billion in August 2010 as compared to $43 billion for the US for July 2010),the current account is comfortable due to high degree of capital inflows. We have seen the Indian rupee appreciating by close to 3% in the last three months. In the last three years,the Indian rupee has seen a high of Rs 51 and a low of Rs 39.20 to a US dollar. Such sharp swings impacts exporters and have a long-term impact on their hedging abilities.

China has managed its currency very well and provided a stable platform for its exporters. With the currency wars intensifying across all nations,focusing on weaker currencies to boost exporters,India cant be left behind. At some point in time,our central bank has to step in. It has to actively arrest the inflow of hot money. It has to regulate the quality of capital flows. At the end of the day,a strong currency with a high trade deficit not supported by long-term high-quality capital flows is not in Indias best interests.

The author is the chief financial officer of Infosys Technologies Ltd

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