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Geopolitical Tension & Inflation spur de-dollarisation! Time for Rupee to gain!

TIOL - COB( WEB) - 825
JULY 21, 2022

By Shailendra Kumar, Founder Editor

THE global economy has got into a tizzy - swirling economic headwinds! Rather, it has been sucked into a high-intensity whirlwind of multi-layered crises! Fidgeting time for all of us! Kicking up dust would not help! Inflation has been raining down like warheads over a large number of countries. A sort of paroxysmal financial attack! A gravity-defying development for financial and policy wizards across the world! The crisis in-tray is obnoxiously monstrous! Many political leaders may cut a pathetic figure by either reclining on their office sofas only to see daylight nightmares with open eyes or by simply jetting out of the country (a la Gotabaya) with the conviction that not all problems are meant to be solved! Many may even squander their insurance against the further deepening spiral of crisis which has begun to look like a 'creeping grass on steroid'! I can bet dollars to doughnuts - the world is slow-walking into a protracted era of economic and political exasperation! All the symptoms match with Tourette's Syndrome!

The G20 leaders and also the bosses of the central banks jaw-droppingly failed to read a faintly-graffitied message on the wall which was 'inscribed' by the pandemic! In the first 12 months of the COVID-19, a string of lockdowns across the world had broken the 'critical discs' of the spine of the global supply chain! But the eyes of the political leaders remained transfixed on the demand side! And they blind-foldedly loosened their treasury-faucets, pumping in oodles of money in the hands of households. It is not that no stimulus was entailed at that point of time but restraint was denied its 'pound' of attention! Post-stimulus economic behaviour was scaringly not factored in! Then came the era of withdrawal of lockdowns. With wallets spilling over, consumers displayed what they are historically known for! Their basic instincts, particularly in a neo-capitalist society, are to buy two or three units where one unit is needed! This nudged the 'creepy elements' of the zombie of inflation. The initial price-rise was not taken with any pinch of salt, and this is where the Federal Reserves extravagantly goofed up! It was cock-a-hoop with the pace of economy recovery - a false dawn, and its political master thought that the snarls of supply chain would ease in the months to come!

Perhaps, macro indicators of the American economy would have stabilised but for the lack of geopolitical oxygen! The bilateral relations between the US and China sank to a new low. Then came the second mortal blow from Russia which invaded Ukraine. And, the third kick came from China which stubbornly stuck to its dynamic Zero-Covid policy. The consequential lockdowns virtually shut down the factories of the world which broke some more hinging discs of the spine of the supply chain! All these factors sparked a horrifying spiral in the prices of energy, commodities and other consumer durable goods. What made markets uglier were the economic sanctions imposed by the West. With the US weaponising economic sanctions, a major linchpin of its foreign policy, over the recent geopolitical history a la the Trump era, Russia retaliated by slashing gas supplies and crude oils which in turn catapulted the price to over USD 120 per barrel. As the OPEC+ failed to leg up production to bridge the shortfall, higher energy and commodity prices began to gobble up forex reserves of most of emerging and poor economies. Lanka and many others are live examples!

The smug Federal Reserves found itself in a quite pickle! It knew that it would be damned if it kept raising interest rates, and simply damned if it did not! A scenario akin to the proverbial truth - Marry in haste, repent at leisure! Anyway, it finally raised the rates, marginally, to tame inflation! Central Banks including ECB and the Bank of England, followed suit. Then quickly descended the realisation that the marginal hike would not bear any fruit and it twirled in panic, raising interest rates twice at a short interval. Such a panic-stricken measure triggered a spate of hikes across the world. RBI swooned and did the same by stepping out of its fixed cycle. With the June month retail inflation going beyond 9% for the US, the Fed is bracing up for three more hikes in the coming weeks till November! And these anticipated hikes have resulted in bloodless massacre in the emerging economies like India. Over USD 14 bn worth of stocks have been sold out by foreign investors who have buggied their money to the US as dollar is widely treated as a safe haven! Investors have withdrawn close to over USD 71 bn from the Asian bourses. 'Airborne' dollars have hugely weakened the local currencies in Asia and Europe. And the glut of deposits has dynamically added muscles to the greenback. The appreciating Dollar Bill has triggered an upheaval in the global currency markets. Although it is good for the US as its imports become cheaper and may tamp down soaring inflation but it is a hugely costly affair for dollar-reliant economies like India which imports almost 82% of its energy needs. Though the RBI claims that it has, in the past six months, diversified its basket of forex reserves by enhancing the percentage of non-traditional currencies like Swiss Franc & Yuan but it needs to set a long-term goal to provide stability to the rupee.

Meanwhile, appreciating greenback has sparked a mayhem for euro, yen and others. One predictable consequence which may further accelerate the declining percentage of US dollar in the global forex reserves kitty - from 70% to 59% in the past 25 years, as per IMF, till September 2021, is going to be a big coercive push to the process of de-dollarisation. And the key de-dollarisers are going to be China, Russia, Iran, Venezuela and many others owing allegiance to their camp! What may further spur the anti-dollar trend is the focus on digital currency by several central banks including RBI. China is toying with the idea of e-Yuan for long! Given the present trend of many stable economies like Australia, Switzerland and Sweden, promoting their own currencies for global trade, they may further eat into the space being occupied by the US dollar.

Israel has recently decided to reduce its foreign assets in US dollar and switch to non-traditional currencies like Swiss Franc, Australian dollar and others. Russia has already begun insisting on doing trade only in roubles or a currency of a close pal. For instance, Indian refiners were recently told to pay in UAE Dirham if they wanted to avail heavy discount on crude supplies. China has, for long, been working on an alternative global payment system to the US dollar-dominated SWIFT which is routed through New York. And China recently claimed that over 135 financial institutions are on board its network. Russia, Iran and many others have already reduced their exposure to US dollar over the years. Some of the powerful economies would prefer promoting their own currencies in their geographical vicinity. EU has already been doing it and, now caught in crosshairs of war and energy crisis, it would certainly have a long-term policy to depend less on US dollar!

What I clearly see is that with the geopolitical landscape getting fractured into multiple slivers, a sizeable number of economies would prefer doing regional trade in regionally-dominated currencies such as Euro, South African Rand and even the Indian rupee! A new era of swap or barter system would roll out to minimise the harms coming from the volatility in the US dollar, plunging into a reverse currency war and a 'Doom Loop', perhaps! It offers an opportunity to India on a platter, to put in place a long-term rupee-promoting policy so that its growth does not suffer in the future! Secondly, a strong currency is emblematic of the heft of an economy too! One of the key consequences of inflation-taming policy is the by-default sacrifice of economic growth which India cannot afford at this historic stage of rapid growth necessity! For the US economy, the muscled dollar is bound to trigger recession which is almost knocking on the door! Unfortunately, it would have a butterfly effect on many poor and emerging economies which would lose their night sleep and face unrest in job markets. Their distance to prosperity would lengthen. So will the widespread frustration and trepidation! Let's brace for a painful 'session' of recession! Time to gird for dragon's breath era ahead! No room for shoot and scoot! Uh-oh! Take cover!