The G20 meeting in Seoul next month ( November 11 and 12th) for the Finance Ministers of the twenty member countries that include India, China and the US, is likely to be a stormy one judging from the controversies surrounding the state of the world economy. The G20 formed in 1999, represents 66 per cent of the world’s population and 85 per cent of its total output and is a self appointed group without any legal basis. It was formed initially to address the problem of overhauling of the international financial system and the last meeting was held in Toronto in June 2010.
It is a forum which is meant to discuss global problems and today, the world is witnessing a period of unforeseen global imbalances in which all countries are trying to protect their own interests regardless of what happens to others. There is no agreement on the diagnosis of the problem either and there is a clear divide between the views of debtor countries like the US and the UK and the emerging market economies (EMEs) like India, China, South Korea and Brazil which are growing at a relatively faster rate.
All the EMEs are faced with a deluge of FIIs ( Foreign Institutional Investments) originating from the developed countries, and are looking for better returns for their money. In their own home markets, there is no guarantee about the possibility of a sustained economic recovery from the global downturn that began with the financial crisis in Autumn of 2007 .
The entry of the FIIs in the EME markets is lowering the value of the local currency in terms of the dollar and most countries are faced with a problem of reduced export competitiveness. China is the main culprit blamed for its currency manipulation and keeping the value of the yuan down in order to push its exports. Other countries like Thailand, Japan and South Korea have followed suit and have intervened vigorously to keep their currencies’ value low against the dollar.
There is a strong protectionist flavour to all these currency manipulations because the affected countries are trying to promote exports and prevent imports from flooding their markets.
India has been the least active in currency manipulations and many exporters have been hurt with the value of the rupee rising against the dollar. The hardening of the rupee against the dollar to Rs 44 recently has meant higher quoted prices for exports in the international markets. The reason for the hardening of the rupee has been the huge influx of FIIs into India amounting to $ 20.34 billion in 2010. The FII inflows from the rich countries are also due to their very low interest rates, almost close to zero whereas the Reserve Bank of India has raised interest rates five times in the past one year. Recently however, the RBI has been buying dollars in the market to stabilize the rupee.
Thus at the Seoul G20 meeting there is going to be a confrontation between the developed countries which have kept very loose monetary policies with low interest rates to stimulate their economies and the EMEs which have been facing the unforeseen inflow of short term funds from US and EU.
China is wary especially of the US’s increase in the supply of dollars or Quantitative easing, which is a part of its loose monetary policy. The printing of fresh dollars can amount to $600 billion to $1 trillion. The extra supply of dollars will surely bring down the price of US currency further. China has continued to buy dollars in the recent months to prevent an appreciation of the yuan. As a result, China’s foreign exchange reserves grew by $195 billion in the third quarter this year. The US trade deficit with China in August was at $28 billion. Japan also has tried to hold the value of the yen down in the past few months when it faced an 18 year high value of the yen against the dollar. Other countries that have actively intervened are Thailand, Brazil and South Korea. Brazil and Thailand have imposed taxes on the FII inflows.
China however is causing problems for its neighbours which are not able to devalue their currencies in response to the FII inflows. In response to the urgings of the US, China revalued the yuan only by 3 per cent instead of the requested 20 per cent, recently.
China has also raised its interest rate by 25 basis points ( 0.25 per cent) in order to control inflationary pressure and overheating of its economy. This move could increase the inflows of FIIs and raise the value of the yuan against the dollar. But China may not allow the yuan to rise and instead just let the interest rate rise calm rising commodity prices.
In all fairness, instead of blaming China of currency manipulation, the US also should restrain its monetary easing and not create a flood of dollars in the international markets. The US through its monetary policy of low interest rates is obviously trying to revive its economy and create jobs. Its ban on outsourcing which has been much criticized by developing countries especially by India, is also aimed at preserving jobs in the US. The likelihood of a more aggressive protectionist stance by US is bothering all EMEs.
In fact by increasing the flow of the FIIs in the international markets, the developed countries have helped to stoke inflationary pressures in the Emerging Market countries which are all battling with price control whereas there is low inflation in the US. Moreover, all EMEs are also facing lower industrial growth including India. There is also the fear that too much money inflow is creating an asset bubble which can burst any time plunging these emerging markets into a downward spiral.
Today with all the wrangling of currencies that the world is facing, there may emerge some hope from G20 meeting with some agreement on the way ahead. But it may also remain only a talk shop in which there is no consensus.
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