RBI governor warns of trade wars turning into currency battles

RBI governor warns of trade wars turning into currency battles
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Mumbai, Aug 2: Reserve Bank of India (RBI) governor Urjit Patel warned that ongoing trade wars might escalate into currency wars, leading to more volatility in financial markets. This uncertainty appears to be one of the triggers behind the rate hike as higher interest rates, besides taming inflation, also support the rupee.
“We’ve already had a few months of turbulence behind us and it looks like that this is likely to continue. For how long, I don’t know. The trade skirmishes evolved into tariff wars and now we are possibly at the beginning of currency wars,” said Patel in his post-policy interaction. Patel said that given such an external environment, the central bank has to run a tight ship on the risks it can control to maximise the chances of ensuring macro-economic stability and continuing with the growth profile of 7-7.5 per cent.
Hinting at sticking to the deficit targets, Patel said, “We do have things that are in our favour, which you’re aware of, and if we continue along that path, we ensure that we don’t add to the global risk profile that would adversely affect us.”
The governor’s statement comes at a time when China has responded to tariffs imposed by the US with a devaluation of the yuan. According to experts, China’s devaluation will export its trade problems to even those countries that are not engaged in any trade war. July saw an 8 per cent drop in the value of the Chinese currency vis-a-vis the dollar since April, marking its worst four-month fall on record.
Given that the People’s Bank of China has not done much to break the fall, many feel that the devaluation is part of a stimulus package. A weaker yuan will offset the positives arising out of a weakening rupee and will also encourage Chinese exporters to dump goods in the Indian market.
Keeping in mind the volatility in foreign exchange markets, the RBI said in its policy that it will amend the Foreign Exchange Management Act (FEMA) to allow Indian multinationals to hedge currency risks of their global subsidiaries from India. The country’s forex reserves have come under pressure as the RBI has sold dollars in a bid to support the rupee. From $411 billion in January, reserves are down to $405 billion and there is a risk that it may fall below the $400-billion level. In the medium term, rising foreign direct investment flows — which includes the $2-billion inflows from HDFC Bank’s ADR — are expected to support the rupee.
SBM Holdings CEO (India and East Africa) Moses Harding said, “The RBI is seen to have weighed on external cues largely from the Brent crude’s resilience at the lower end of $70-80, the US dollar’s strength while the dollar index is at lower end of 94.15-95.65, the sudden spike in US 10-year Treasury yield from 2.80-2.85 per cent to 2.95-3.0 per cent, and declining FPI flows from yield spread squeeze, making the rupee exchange rate not attractive to hold and accumulate investments in India.”