Moneycontrol Pro Panorama | Regulating the economy temperature gauge

There isn’t a crisis brewing currently, but some economies are facing challenges and it is evident in their exchange rates.

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Exchange rates serve as temperature gauges for markets and economies. When exchange rates are in the news, most times the economies they represent are facing challenges. Ignore their warnings for a long time, and they result in a full- blown crisis for the economy (think the 1990s Asian crisis).

There isn’t a crisis brewing currently, but some economies are facing challenges and it is evident in their exchange rates. The Turkish Lira is hitting new lows as President Recep Tayyip Erdogan won the local elections to extend his rule for the third term. Erdogan’s policies are seen as unfriendly for markets and the Lira is showing exactly how unfriendly. In Africa, Tanzania tightened controls on its currency citing a dollar shortage. International exchange rate brokers are not allowed to buy or sell foreign currency in Tanzania.

Let’s move to the big-league exchange rates that hold sway over global markets. The Chinese yuan has weakened steadily as recent economic data has shaken the faith in Beijing’s economic growth recovery. But a weak currency works for China as its exports are a big driver of its economic growth. In fact, most of Asia has a similar story when pitted against the dollar. Currencies from the Indonesian rupiah, Thailand baht to Vietnamese dong or Korean won have remained under pressure against the US dollar.

What has also impacted Asian currencies is the recent drama on the US debt ceiling. Washington has reached closer to achieving an increase in the debt ceiling which will likely to prevent a historic debt default by the US. But the debt ceiling bill must pass through the Senate without any delay to avoid the default on June 5. Markets are on tenterhooks and exchange rates have weakened across geographies. After all, if the dollar becomes a default currency, what does it say for others?

That brings us to what seems to be the theme of this decade: upending the US dollar hegemony. The Russia-Ukraine war has laid bare a polarised world and those that do not want to be allies with the West have begun to circumvent the need for the dollar in trade. As this Bloomberg piece details, countries are striking deals with trade partners to use their own currencies instead of the dollar. China seems to be the orchestrator, the only economy with size and heft that can match the US somewhat.

But can you bypass the dollar when it still is used to bill more than 90 percent of trades? As Russia found out recently, it is left holding a large pile of rupees locked abroad from its export of crude oil to India. Officials of both countries are trying to hammer out a solution wherein Moscow can invest rupees in Indian markets. After all, what good is capital if it cannot be moved into the country and is locked up in a foreign currency?

For India, the going has been smooth. The Indian rupee has weakened albeit at a slow pace and engineered largely by the central bank. As exchange rates are temperature gauges, central banks keep a hawk’s eye on them, and many have a tight grip on them to prevent untoward accidents. Indeed, the market interventions of even the most neutral central banks have increased of late, driven by the surge of the dollar.

The Reserve Bank of India (RBI) is an old hand here. As our Chart of the Day shows, the central bank has increased its presence in the market under the current Governor Shaktikanta Das, keeping the volatility to its absolute minimum. The latest surprisingly strong economic data has only added to the strength of the exchange rate. While India is keen to make the rupee an international currency, meeting the requirements for the same is far from easy. The rupee needs to be fully convertible and its share in trade billings must increase. Signing pacts with trading partners such as Malaysia and Russia for greater use of the rupee is a start, but it has a long way to go.

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Aparna IyerMoneycontrol Pro