Currency Wars on the Horizon

German Economy Minister Rainer Bruederle, is said to have quoted two weeks ago, “"The danger of a trade war has appeared on the horizon," and "The danger is that complaints about currency undervaluing lead to retaliatory measures, which could eventually turn into a trade war".

The appreciating Indian Rupee vis a vis the US dollar has been sending alarm bells ringing in companies in the export dependent IT-ITES sector in the last few weeks. One primary factor has been India’s stock market. The recent spurt in the stock market has been greatly fuelled by influx of FDI. This has been having an appreciating impact on the Indian rupee and the depreciation of the dollar has seen the bottom line of Indian IT companies being hit.

To understand this better, one can see that the rupee has fluctuated from a high of 51.9 to the dollar to a low of 43.9 in the last two years and is currently at 44 to the dollar. Associated with higher cost of operations is the fact that there have been stringent requests by clients to decrease billing rates. Another impact of the heavy inflow of FDI has been that the RBI has been forced to purchase dollars to try to keep the Rupee on track. It is believed that this would have an inflationary impact on the Indian economy making cost of operations even higher.

While this in itself is not good news, there is much more happening. In the background of the currency fluctuation, it should be noted is a trade war going on which has not got the attention it deserves. This is a semi-official trade war in currencies being fought by the Americans and the Chinese, whose effects could be even more costly for companies in the coming months and years.

Global Chinese exports in the year 2009 are estimated to be about $ 1.2 Trillion, of which $ 300 billion were to the US. There has been a raging controversy in the US that unfair currency practises by the Chinese has been hurting American Competitiveness. It is felt in the US that the Chinese keep the value of the Yuan artificially low to boost their exports. It is felt that even if the Yuan appreciated by some %age, Chinese exports would be less competitive, making life easier for American companies. Also the depreciation of the US Dollar is being felt as a tool to become competitive in Trade and thus help to get the US out of the quagmire of economic recession it’s in.

With that background, to indirectly nudge its trading partners, a bill was passed in the US House of Representatives, on 29th September, 2010 titled “H.R. 2378: Currency Reform for Fair Trade Act”, to basically allow “countervailing duties to be imposed to address subsidies relating to a fundamentally undervalued currency of any foreign country.” Another bill which has been introduced is “S. 3134: Currency Exchange Rate Oversight Reform Act of 2010”.

For many of us, this may seem like a trade war to be viewed on CNN. However the implications could be quite substantial to the Export dependent companies. The specific threats from these bills are that:

They propose measures, like charging rebated Value-Added Taxes as an import duty. This implies that if a company gets a rebate on exports in its home country, which most do, then a countervailing duty could be imposed by the US to ensure fair competition in the American Market, as it is perceived that this rebate allows companies to unfairly lower their prices. Another threat is that Congress and the US President could levy taxes “to obtain compensatory tariffs against currency-subsidized imports.”

Such is the concern that Guido Mantega, Brazil's Finance Minister, declared last month that the world is already involved in "a trade war and an exchange rate war," and that Brazil would take action to defend its economic interests.

“To open a shop is easy, to keep it open is an art” – Chinese quote