Currency volatility – Is it a by-product of the US-China Trade war?| RBI Grade B 2019 Question

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Currency volatility – Is it a by-product of the US-China Trade war?

Volatility in the world economy is the current trend with a major focus on domestic production to curb imports. The trade war began in 2018 between the US and China, as the latter ordered its state-owned companies to halt all imports of agricultural products from the U.S., in retaliation to President Donald Trump’s most recent round of tariff threats.

The fluctuating rate of yuan to more than 7 per USD in the currency market, has branded China as a currency manipulator by Trump’s administration. Beijing’s move to weaken the yuan was clearly made in retaliation to Trump’s latest tariff threat. The U.S. law also states that the U.S. government is allowed to eventually impose penalties on China, which will prohibit the Chinese companies from U.S. government contracts. The president also announced recently that Washington will levy 10% tariffs on $300 billion of Chinese goods starting 1^st September, which will leave U.S. with imposed elevated tariffs on all goods it buys from China. Eventually, this will indulge a direct U.S. intervention in the currency market.

In response to this move by the US government, the Chinese communist party prefers to keep their domestic currency weak to make the exports competitive. Currency wars are quite common as their best weapon is the currency. This will help balance out a large part of the tariffs, the US has introduced.

The growth of a nation is weighed in terms of all the sectors. The trade war initially spilled into the technology, manufacturing and oil sector, with a gradual influx into the currency sector recently. Sliding of the Chinese yuan past 7 is indeed a prelude to a protracted conflict between the two countries.

Impact on the world currency market

The US-China trade war has a negative effect on global markets. The escalation has shaken the world markets as nervous investors looked for safe places to invest. Wall Street is on a roller coaster ride, with the S&P 500 closing down nearly 3% in Europe. Selling was especially heavy in the trade-sensitive technology, consumer discretionary and industrial sectors.

The trade war has led to depreciation of the currencies, thereby making the goods cheaper to sell abroad and help the businesses and consumers to offset the additional tariffs imposed by the foreign land. The extremely volatile currency market is a direct resultant of unilateralism and trade protectionism measures, which in turn is further escalating pressure between the countries.

The move created a ripple of wave in the markets, with S&P 500 Index futures sliding more than 1% in Asia.

Japan’s Nikkei stumbled almost 2% to the lowest since early June, while Australian shares slipped about 1% to spend their fourth straight session in the red. South Korea’s Kospi tumbled 1.2% to hit the lowest since December 2016.

US shares were pegged at a lower price after US President Donald Trump declared that though some negotiation was on with Beijing, yet they would not compromise.

Those comments helped to drive a late sell-off in a volatile session that saw the Dow Jones Industrial Average fall 0.34%, the S&P 500 lose 0.66% and the Nasdaq Composite drop 1%.

Dynamic Rupee Movement

The rupee plunged the most this year amidst a broad sell off in Indian markets, spurred by a crash in global markets, reeling under the effects of the US-China trade war. The Indian currency fell 1.7% to 70.59 in the first week of August compared to last week’s close of 69.59 against the US dollar.

Nomura Securities Ltd have made a forecast for the rupee to weaken to 72.5 against the dollar in 2019. The trade war is essentially the major contributor to a retarded economic growth, which in turn leads to lower interest rates and a relook at risky emerging market assets. A weaker rupee offsets the benefit of lower commodity prices on domestic inflation, potentially spoiling the opportunity for policy rate cuts.

Considering the dollar is flowing back to US bonds, Indian markets are going through a cash outflow. Foreign investors have started to dislike India because of heavy taxation norms.

The trade war has an adverse impact on the dollar borrowings of Indian companies. External commercial borrowings have surged in recent months and a depreciating currency inflates repayments for the borrowing companies, thereby making it tougher. Research shows that a depreciating currency has a greater impact on the balance sheet of a company than its revenue because of the dollar borrowings.

However, every economy tries to devise corrective measures to keep the growth momentum amidst these adversities.

Remedial Measures

In retaliation to the US allegation of being a currency manipulator, the Chinese Government has introduced few measures which helped to limit the Yuan plunge to bring stability to the markets. The Yuan soared by 0.2% a day to comply with the world economy dynamics and soften the impact of higher tariffs. Any liberalization of the yuan would now probably lead to Chinese exports becoming even cheaper — hardly the outcome Trump would want. China has to be cautious of using a weaker yuan as a weapon in the trade war, otherwise it will slide into a full-blown crisis.

Alongside, developing nations like India needs to safeguard their domestic growth and their currency exchange rate, with special emphasis on solving the taxation issues. Foreign investors would need a better clarity to be able to invest in the Indian stocks again. Hence, the trade war is proving to be detrimental to the success of many nations, which needs to be averted.

References:

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