Currency war or inward orientation?

Currency war' or 'competitive devaluation' is a buzzword today. Interestingly, given the cause of devaluation as gaining export advantage and price-competitiveness in international trade, it raises a fundamental question about the appropriateness of excessive export-dependency of an economy to achieve high growth-rate for itself. Is there any alternative growth model that will keep the economic engine firing on all cylinders, even if export demand plummets? And how is it related to the real economy, namely the growth rate, employment, investment and inflation? These are questions needing urgent attention and it's imperative for management students to comprehend it in depth.

It's common knowledge that, for example, when the rupee depreciates from 45 to 46 per dollar, Indian exporters get one rupee extra for export worth one dollar. A smarter businessman would, rather than partying with the extra rupee, reduce the price of his export from $1 to $0.98, yet get Rs 45 at the new depreciated exchange rate. This gives him competitive advantage in the international market. This is how China has swept the world market with undervalued renminbi, besides their lower cost of production. Many developing nations, including India, have kept their currencies undervalued vis- -vis their PPP levels, to gain export advantage. While helping exports, devaluation or depreciation discourages imports, which is not bad for the BoP. So countries are interested in keeping their currencies suppressed. Countries that do so get advantage over those who don't, but in case all countries start devaluing their currencies in competition with each-other, it amounts to a 'currency war', the term coined by the Brazilian FM Guido Mantega. It's like a price war if one looks at the exchange rate as price of one currency in terms of another, usually the dollar. If all countries adapt the practice, including the US, it would become a zero-sum game with no one benefiting but all losing faith in the stability of international financial system and getting suspicious about each-other. Hence the strong objections and worries about currency war worldwide.

. It's common knowledge that in a fixed exchange rate regime the exchange rate is determined and maintained by the central bank of the country, while in a free floating regime it's decided by the market forces of demand for and supply of the currencies. In a 'managed float' however, the currency is allowed to move by the demand-supply forces, but in a certain 'band' decided by the central bank, like a 'snake in a tunnel'. Most currencies, including the rupee, are on a managed float. RBI intervenes by buying dollars and selling rupees if it wants to keep the rupee from appreciating, since an appreciating domestic currency hurts exports. But when it does so it ends up releasing excess rupee supply in the market, which leads to inflation. To avoid this undesirable spin-off, RBI mops up the excess money supply by selling government bonds, thus sterilising its intervention.

Other reasons for rupee-appreciation are dollar inflows through FDI, FII, ECB, foreign remittances, export earning and hence other measures to control rupee appreciation include capping FDI-FII; ECB to be spent in dollars, partial convertibility of rupee, lower interest rates, etc. The issue at present is, the countries that didn't intervene so far have started doing so. For example, Bank of Japan has started devaluing yen after years of non-intervention. Korea, Taiwan, China, Malaysia, India all have undervalued currencies vis- -vis PPP levels. There is also a debate whether it really is a currency war or no. Because, the currencies that appear devalued today were actually strengthening during the 2008 crisis and now are only moving back the pre-crisis levels. It would be rather premature and even irresponsible to spread panic by using strong words for a potent problem.