TRADE WARS RESURGENT: RESHAPING THE GLOBAL ECONOMIC LANDSCAPE

S. Mohini Ratna,
Editor-VARINDIA

The world economy is grappling with mounting challenges as trade tensions resurface and major central banks adopt conflicting monetary policies. These developments have created a widening fault line in the global financial system, posing serious risks to growth, financial stability, and especially the economic well-being of emerging markets.

On June 20, 2025, the European Central Bank (ECB) announced a dovish policy shift, hinting at a potential rate cut in July. With Eurozone inflation at 2.3%, the ECB also committed to reducing its balance sheet by €50 billion. This announcement led to a 1.7% decline in the euro, pushing the exchange rate to $1.06 and driving up import costs across Europe by 3%. Meanwhile, the Bank of Japan (BoJ) maintained its accommodative stance, retaining a 0.1% interest rate and injecting ¥1 trillion into bond markets. Although this spurred a 2.5% increase in Japanese exports, it also escalated domestic import costs due to the weakening yen, which hit ¥159 against the dollar.
 

In contrast, the U.S. Federal Reserve maintained its hawkish posture by keeping interest rates at 5.25–5.5%, citing persistent inflation of 3.1%. This policy has attracted capital flows from developing nations, creating growing imbalances in global liquidity distribution and deepening stress on emerging economies.
This divergence in policy has triggered severe currency volatility. The Indian rupee depreciated sharply to ₹86.45 per U.S. dollar, mirroring broader trends across emerging markets. According to the Bank for International Settlements (BIS), developing economies have lost over $2 trillion in capital since 2024. The BIS’s 2025 Triennial Survey warned that the continued dominance of the dollar could destabilize 60% of emerging economies, particularly those already vulnerable to external shocks. Currency depreciation has been especially severe in countries like South Africa and Brazil, where the rand and real fell by 2% and 1.8%, respectively.

India, despite its strong domestic demand and sound macroeconomic indicators, is not immune to these global currents. Consumer Price Index (CPI) inflation was recorded at 2.82% in May 2025, but further rupee depreciation is expected to push inflation to 3.7% by Q3. The country's current account deficit, already at 1.2% of GDP for FY26, could widen significantly if global conditions deteriorate further. Economists warn of a potential $5 billion increase in the quarterly deficit under worsening circumstances.

These pressures are being felt in Indian financial markets. On June 20, the Sensex fell by 0.2% to 81,282 points, following $1.5 billion in foreign institutional investor (FII) outflows. This capital flight caused a spike in 10-year government bond yields, which rose to 6.85%. Major IT exporters like Infosys and TCS also saw declines due to renewed concerns over U.S. tariffs and demand uncertainty.

The Reserve Bank of India (RBI), with $650 billion in foreign exchange reserves, is expected to intervene in currency markets to stabilize the rupee. Anticipated measures include the sale of $2 billion monthly from its reserves and the activation of $10 billion in swap lines. Additionally, a 25-basis-point rate hike in August is being considered to counter inflationary pressures, though such a move could weigh on domestic consumption and investment. India’s resilience, built on a domestic demand base accounting for 66% of GDP, offers a buffer but cannot fully insulate it from global shocks.

Adding to these monetary risks are geopolitical tensions and protectionist trade policies. Escalating hostilities in the Middle East, particularly between Israel and Iran, have led to a spike in Brent crude oil prices, which touched $77.28 per barrel. For energy-importing nations such as India and many ASEAN countries, this poses an additional inflationary threat.

India, through the RBI, is uniquely positioned to lead a global effort to mitigate these challenges. A proposal first floated by UNCTAD calls for a $500 billion global swap line network—a mechanism that could help stabilize currencies, ease capital flight, and provide essential liquidity to vulnerable nations. With its strong reserve position and leadership at the G20 level, India could champion this multilateral solution and offer a lifeline to the 1.2 billion people most at risk of economic displacement due to inflation and currency crises.

Ultimately, the current trajectory of protectionism and monetary fragmentation endangers global stability. Central banks must rise above national agendas and embrace multilateralism. India, with its economic heft and strategic reserves, is well-placed to lead this charge. The G7 must act decisively to support such initiatives, or risk the collapse of the fragile global economic balance that sustains shared prosperity.