As the second wave of COVID-19 starts showing its effect in India, we look at how things will play out amid the crypto-boom; what’s causing it, what it means and how it will impact the world economy at large.

Economies reacting to COVID-19

As the vaccination race is now in full swing, countries all over the world are about to face divergent health and economic outlooks. High vaccination numbers are key to reducing the impact of COVID-19 and the need for the lockdowns it makes necessary. Based on the order of completion of vaccination programmes, economies are expected to fall in a hierarchy of sorts. If you recover first, you can start producing necessary items first and trade them at higher and more favorable prices. We certainly hope this doesn’t extend to ventilators and vaccines themselves, however, it is very likely to.

The United States, Germany, France, and the UK have pledged to help India amid the deadly second wave of COVID. These countries have offered to help with the necessary equipment, ventilators, oxygen concentrators, and other devices. Denmark and other countries in the EU are also pitching in to help India in its crisis that has taken a turn for the worse.

As developed economies recover from COVID through high vaccination rates, the global demand is expected to rise, and as an effect so shall inflation. Simple economics, high demand means a higher price. Countries like the US and the UK which have high vaccination rates at 39% and 47.8% are already experiencing high inflation because of surges in demand. However, since vaccination is not the same everywhere there are going to be diverging economic cycles as a result of this race.

Hyperinflation Hell

Because of rising prices and low production rates, most economies entered a phase of stagflation. High inflation is expected to be a reality for all countries with the increasing demand, however, for countries like India, Indonesia, Bangladesh, and Columbia the situation is expected to be worse because of the low vaccination rates which make lockdowns necessary and thus, production and manufacturing difficult. These countries will face the two devils: the first being COVID itself and the second, the high inflation rates that will follow and erode the value of their currencies and the savings of their citizens.

Imported inflation is a greater concern in such countries as the prices of imported goods and goods that need to be imported (because of low production) are both expected to rise and feed on each other. In India, the wholesale price index touched an 8 year high of 7.39% driven by global fuel and manufactured product price rise.

This is one of the problems with managing high inflation amid COVID’s second wave. If the disease doesn’t get you, it certainly will get your savings. As the prices of commodities rise, they eat away the purchasing power people have stored in their bank accounts. If your savings in your bank account are to have the same power they had before inflation they need to increase at rates higher than the rate of inflation itself! However, if you do that; supposing you figured out the accurate rate you need to keep, you’d probably end up choking the economy for credit. High interest rates mean higher rates for loans and that means it’s difficult for industries to get back up after extended lockdown. A very tricky balancing act all central banks have to handle.

Alternate currencies that thrive on uncertainties

This phenomenon has set off a monetary exodus in multiple economies from the traditional bank accounts and to cryptocurrencies. The logic behind this is simple. Most currencies and bank accounts are now depreciating assets because of the high inflation eroding their value. People want to find assets that will keep it’s value in this crisis to store their savings and cryptocurrencies, particularly Bitcoin, seem to be the answer for them. This shows a lack of confidence in the currencies themselves as they fall in value.

This is a trend reflected in the recent listing of Coinbase, a marketplace provider for cryptocurrencies where about 5% of the transactions in cryptocurrencies happen. The company is evaluated to be 99.6 billion dollars. The crypto market itself now stands at a whopping 2 trillion dollars.

(Bear in mind that Bitcoin is just 13 years old and Coinbase is 10 years old. The latter is now an exchange bigger than global exchanges like CBOE, ICE (owns NYSE), and Nasdaq. What’s impressive is that many countries have heavily regulated the cryptocurrency market, but still this market has boomed, especially due to COVID.)

It should be noted that since Bitcoin is seen as an alternative to keep your savings in, as opposed to dollars in bank accounts, there is a negative correlation between the dollar and Bitcoin. Sometimes a fall in the confidence of the dollar will trigger demand for Bitcoin, this trigger is especially high during these times when inflation is very high due to the pandemic’s effect on the dollar.

As more money is stored and locked in cryptocurrencies, it is also out of bank accounts and thus credit creation suffers. Since there are fewer deposits with banks they will find it difficult to provide loans and the interest rates might rise.

As value falls out of banks, banking becomes difficult. Will banks themselves cease to exist? Of course not! They will simply start accepting crypto deposits and use them to give loans. However, that’s easier said than done and it will require a lot of changes in the banking system and for some time this might create an upwards pressure on interest rates.

Rupee depreciation

The impact of currency depreciation due to inflation has been seen in India as the rupee fell back to a rate of 74.93 rupees/US$ in April after a period of a slight recovery in previous months. It should be noted that the dollar itself is not as healthy as it used to be.

Between October 2020 and February 2021, 1.94 lakh crore Rupees were pumped into the Indian financial markets by foreign portfolio investors. They now seem to be pulling out in April as the second wave of COVID hits India. This is expected to depreciate the rupee further.

Along with the aforementioned economic effects that come with high inflation, this could seriously affect the value of the rupee. As the rupee falls the imports are expected to be more expensive in a situation where domestic alternatives are not available due to the expected lockdowns and thus we have a downward spiral of high inflation, costly imports, and depreciating currency.

How does the crypto-boom affect the rupee?

Even after initial regulations, India has been drawn to the crypto markets at a lightning pace as expected. As Indians start saving in cryptocurrencies and trading even, it is bound to take away value from an already depreciating rupee. People have flocked to get into the crypto economy.

We might not see an exodus to the crypto market as India is still an agrarian country and the rural savings might not move to the crypto economy because of how low they tend to be. Even though the future of the rupee hangs in balance as inflation surges amid extended lockdowns, low-income groups might be hesitant to move their savings to a flippant and highly dynamic crypto-economy.

As value flows out of banks and into cryptocurrencies, credit creation would become difficult as the deposits are no longer stored in banking systems and thus can’t be used to give out loans. This will cause the interest rates to rise. An equilibrium where no more value flows between crypto economies and banking systems will be reached when the yield from both becomes the same. The crypto market is expected to have some barriers to entry for retail investors through regulations and thus we might expect cryptocurrencies like Bitcoin to appreciate at a higher rate than bank deposits as the cost of entry takes away from the yields of crypto.

This is just one possible long-run equilibrium, however, we may expect credit creation to suffer and consequently higher interest rates in India.

Digant Shetkar studied commerce at an undergraduate level at Jai Hind College, Mumbai University. He is passionate about economics, football, stories in all formats, and punk rock bands. (The opinions expressed in this publication are those of the author/s. They do not purport to reflect the opinions or views of The Policy Observer or our members.)

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