Context
The euro recently reached parity with the US dollar. In other words, one euro became equal to one US dollar in terms of the exchange rate. The Euro is the European Union’s currency and monetary unit, represented by the € symbol. It is the official currency of the EU’s 19 member countries.
Relevance
GS Paper 3: Indian Economy and issues relating to planning, mobilisation of resources, growth, development and employment.
Mains Question
How would the recent phenomena of protectionism and currency manipulations in world trade affect macroeconomic stability of India? (150 Words)
Declining value of euro
- The euro and the US dollar recently reached parity, which means that one dollar can now buy one euro in the foreign exchange market.
- The euro has lost about 12% of its value against the US dollar since the beginning of the year, and it is expected to lose even more value in the future.
- The latest blow to the currency has come from the energy crisis that has resulted from Russia’s war against Ukraine.
- This is only the second time since 2002 that the euro has fallen this low to the dollar.
Reasons for the euro’s depreciation against the dollar
1)The Eurozone’s economic weakness:
- The Covid-19 pandemic, as well as the fiscal response to it, had left the eurozone with a weak economy and historically high inflation.
- Germany, the largest Eurozone economy, will run its first trade deficit since 1991 in May 2022.
- At a time of vulnerability, Russia’s war on Ukraine and the subsequent ban on Russian energy have rendered the European economies completely vulnerable.
- Europe was entirely reliant on Russian oil and gas.
- The unprecedented rise in energy prices has resulted in a cost-of-living crisis for the general public.
- It also raised concerns among investors about the viability of future Eurozone investments.
- Many businesses are planning to relocate to the United States, which is far more energy independent.
2) The difference between the US and European central banks’ monetary policy responses:
- The US Fed has stated unequivocally that it will not relent until inflation, which is also at multi-decade highs in the US, returns to the target rate of 2%.
- As a result, the Fed is raising interest rates aggressively, even if this results in a recession.
- In contrast, the ECB has remained unchanged.
- Faced with the possibility that raising interest rates (to control inflation) would dampen economic recovery, the ECB has not raised rates.
- This has created another major reason for money to flow out to the US, which offers higher returns on investments.
3) Russia’s invasion of Ukraine:
- The euro’s value has been influenced by the uncertainty in energy supplies caused by Russia’s invasion of Ukraine and the subsequent actions against Russia.
- Europe is now having to pay more euros to import limited energy supplies, which has harmed the euro’s value.
Impact on Indian Rupee
- Many experts believe that if the euro continues to fall and trend below parity, it will drag the rupee down with it.
- In other words, if the euro continues to fall, the rupee, which is already close to 80 to the dollar, will fall even further.
- This is because the euro has extensive trade ties with India and other emerging economies.
- So far, the rupee has outperformed the euro against the dollar because the RBI has intervened to keep the rupee that way.
- In fact, despite its continued weakness, the Indian rupee has shown greater resilience against the dollar than most other currencies.
- One example is the rupee’s sharp appreciation against the euro since the beginning of 2022.
- It was close to 90 cents to the euro at the start and is now close to 80 cents.
The Eurozone’s Economic Future
- As the Federal Reserve of the United States continues to raise interest rates, the euro is likely to fall further.
- The ECB may be forced to raise interest rates to slow down money supply growth in the Eurozone in order to keep the euro’s value against the dollar stable.
- However, this is likely to slow growth in the Eurozone — 19 countries use the currency — as its economy must readjust to tighter monetary conditions.
- If this is the case, European countries may choose to implement tax and regulatory reforms to hasten the recovery.
