India: Mukherjee warns of currency wars

Emerging Markets, September 2011

India’s finance minister, Pranab Mukherjee, has warned there is a danger of currency wars as emerging market countries seek to avoid the pressures that come with their climbing currencies.

“If the crisis deepens further and there is greater volatility in financial flows, there is an increased risk of this happening,” he said.

“Our view is, if such tensions arise, they should be eased through dialogue, not through competitive devaluations.”

Mr Mukherjee argued that the rising level of emerging market currencies ought to be reflected in the mechanisms used to build special drawing rights, the international reserve assets created by the IMF.

“In the BRIC countries, as their contribution to world output and economy is increasing substantially, therefore the currencies used in these countries should have to be widely appreciated.” That, he said, “should have been taking into account while determining the ingredients of the SDRs.” He added, though, that India was not calling for that today because other factors, such as free convertibility of currencies, need to be taken into consideration. “But the importance of these currencies has increased.”

Reserve Bank of India governor Duvvuri Subbarao said that India was able to absorb the high levels of capital flows it has been receiving, and had no immediate intention of imposing controls upon them. “At the moment we have a current account deficit and are able to absorb the flows that are coming in,” he said. “We are quite unlike other emerging economies which are having a problem of excess capital lows.” He said the RBI would continue to use a range of “quantity and price instruments” to manage capital flows, “so that they bring foreign savings necessary for our development.” He said that using taxation to manage capital flows was “clearly not off the table,” but added: “the question of foreign controls is clearly outside any policy consideration at the moment.”

One of India’s most central challenges today is inflation, which logged a 9.8% (headline) and 7.6% (core) year-on-year increase in August, above consensus expectations. “The high inflationary environment is clearly not going away anytime soon, with underlying inflation pressures firmly in place,” said Leif Eskesen, chief economist for India at HSBC. “Moreover, there are further upside risks to the inflation outlook.”

The Reserve Bank of India has acted aggressively to combat inflation, raising interest rates 12 times and 500 basis points in (WILL CHECK), slowing growth as a consequence, without managing to bring about a decline in the headline inflation rate. But World Bank chief economist for South Asia, Kalpana Kocchar, said that momentum inflation is starting to come down. “The RBI has done a good job trying to put a lid on demand pressure,” she said. “A lot of these pressures are coming from a big increase in rural demand as a result of the push for inclusive growth,” such as a national rural guarantee scheme. “On one hand that’s a good story, putting more money in the hands of the poor, but it’s straining the resources of the economy and that’s causing inflation.”

She said India faces pressure as the only South Asian nation to be fully globally integrated, both on trade and finance, and noted that India’s main stock market index has fallen as much as or further than most developed countries, and more than emerging market composites. She noted “some home-grown problems with regulatory uncertainty and some policy paralysis in India,” and highlighted the need for investment.