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Summary
The conflict in West Asia hasn’t just seen oil weaponized by Iran, it may be setting the stage for a currency clash in the theatre of geopolitics. If Hormuz becomes the pivot of a dollar-yuan contest, central banks like RBI may need to plan for every possible outcome.
As reports emerged last week on which ships Iran had let through the Strait of Hormuz, India-bound carriers of LPG among them, one group was no surprise: vessels carrying Iranian crude exports. By data analytics firm Kpler’s estimate, Iran’s oil shipments kept up an average daily pace of 1.3-1.4 million barrels in March amid hostilities with the US and Israel. Most of it was headed for China, reportedly, bought by small refiners paying in Chinese yuan.
In contrast, the Gulf states that sell the world’s most valuable traded commodity in dollars have found their oil trapped. For decades, a ‘currency war’ has meant a game of mutual devaluation to cheapen exports for a trade edge. Is Hormuz a flashpoint that could spark off a new kind—a petro-currency war?
As the world’s dominant exporter, the People’s Republic has converted about half its trade into yuan. As gatekeeper of the world’s most cheaply extracted oil, the Islamic Republic followed last week’s strikes at oil and gas facilities across the Gulf with a glower at the US alignment of regional monarchies, urging a rethink.
Oil trade in dollars has long helped anchor the greenback’s global liquidity, even after the US quit redeeming it for gold. Since the Iran war began, the dollar has reversed its tariff-led slide, thanks to a jump in demand for dollars as crude, gas and other imports got costlier for importers. Its dominance of trade payments underpins the US role as the global issuer of reserve money.
This may have kept the dollar too strong for US industrial competitiveness, but it also grants America a privilege. It can stretch its fiscal deficit and pile up debt easily, since it gets to borrow cheaply from countries that buy its bonds or export capital to it in other ways.
Where does this war leave the Indian rupee? Hit hard, unfortunately. With our trade gap set to widen amid scant capital flows, the Reserve Bank of India’s (RBI) circuit-breaker role is in focus.
As selling dollars also sponges up rupee liquidity, RBI’s open-market bond buying must increase to neutralize a dry-up. This loop of action has a limit, though, which means the rupee may have to weaken further for interest rates not to get pushed up.
Given today’s conditions, a rupee slide seems more likely to stoke inflation than boost exports, so RBI should calibrate its actions judiciously. Since RBI’s other major trade-off between rates of exchange and lending arises from partial rupee convertibility, tighter curbs on some capital outflows may ease its task. But it would signal a macro crisis and take a severe inflow crunch to justify.
For an optimal currency policy for the Indian economy to suggest itself, the dust of war must settle. On current trends, a dollar-yuan face-off cannot be ruled out. Central banks may need to diversify their scenario analysis accordingly. Geopolitical flux may have turned even ‘black swan’ events grey.
English (US) ·