Central bankers are not loose cannons. What they say matters. So what did RBI governor Urjit Patel quite mean when he warned against trade wars and a probable, incipient currency war? If we discount the possibility he wanted to sound alarmist for the heck of it, Patel’s statement must be understood as a call to maintain fiscal discipline in this election year when the desire to woo voters dominates the politicians’ priorities. Fiscal discipline is the key to macroeconomic balance, which India would need in plenty, if the world were, indeed, to plunge into a currency war.
China and the US are, indeed, engaged in a trade war. The Chinese currency, yuan, has dipped, although not on any scale that would signal a conscious effort by the People’s Bank of China to manipulate its currency down. A currency war is a beggar-thy-neighbour policy, where each nation tries to boost its own exports by competitively devaluing its own currency against trading partners. Such policies have historically failed to achieve stated goals. What has happened most often, is rising inflation from higher import prices, and further slowdown in growth that, as in the case of Japan, can condemn nations to decades of slowdown. For India, the risks of such a war are even more dangerous. We have historically run trade deficits and June figures show this gap widening to a five-year high, based on sharply higher oil. The RBI can allow for a calibrated softening of the rupee against the dollar to make imports dearer and narrow the gap, but the main worry will be the impact of a weaker rupee on oil prices. Dearer oil can seep through as higher inflation, unwelcome in an election year. A better option would be faster growth on the basis of strong macro fundamentals.
Monetary policy will have to be alert against the risk of getting drawn into a currency war. Fiscal discipline, elimination of red tape in project implementation and easing up credit flows to industry and infrastructure will have to become priorities. Politicians can get away with blaming foreigners for many things, but not inflation.