THE CONTEXT: The United States has once again included India in its monitoring list of countries with potentially “questionable foreign exchange policies” and “currency manipulation”.The designation of a country as a currency manipulator does not immediately attract any penalties but tends to dent the confidence about a country in the global financial markets. This article discusses US’s currency watch list and its implications on India.
WHAT DOES THE TERM ‘CURRENCY MANIPULATOR’ MEAN?
- This is a label given by the US government to countries it feels are engaging in “unfair currency practices” by deliberately devaluing their currency against the dollar.
- The practice would mean that the country in question is artificially lowering the value of its currency to gain an unfair advantage over others.
- This is because the devaluation would reduce the cost of exports from that country and artificially show a reduction in trade deficits as a result.
ALL ABOUT US’s CURRENCY WATCH LIST
Why is India on the monitoring list?:
The US Department of Treasury releases the semi-annual report where it has to track developments in international economies and inspect foreign exchange rates.
- India, which has for several years maintained a “significant” bilateral goods trade surplus with the US, crossed the $20 billion mark, according to the latest report.
- The bilateral goods trade surplus totaled $22 billion in the first four quarters through June 2020.
- Based on the central bank’s intervention data, India’s net purchases of foreign exchange accelerated notably in the second half of 2019.
- Following sales during the initial onset of the pandemic, India sustained net purchases for much of the first half of 2020, which pushed net purchases of foreign exchange to $64 billion–or 2.4% of GDP–over the four quarters through June 2020.
India and Singapore had intervened in the foreign exchange market in a “sustained, asymmetric manner” but did not meet other requirements to warrant designation as manipulators.
What are the parameters used:
An economy meeting two of the three criteria in the Trade Facilitation and Trade Enforcement Act of 2015 is placed on the Watch List. This includes:
- A “significant” bilateral trade surplus with the US — one that is at least USD 20 billion over a 12-month period.
- A material current account surplus equivalent to at least 2% of gross domestic product (GDP) over a 12-month period.
- “Persistent”, one-sided intervention — when net purchases of foreign currency totaling at least 2% of the country’s GDP over a 12 month period are conducted repeatedly, in at least six out of 12 months.
Consequence:
- Inclusion in the list does not subject to any kind of penalty and sanctions but it deteriorates the global financial image of the country in the financial markets in terms of foreign exchange policies including undervaluation of currencies to gain export advantages.
- According to some experts, the tag could lead to rupee appreciation as the Reserve Bank of India (RBI) might step back from its dollar purchases.
Other countries on the list:
- The US Department of the Treasury Office of International Affairs, in its latest report to the US Congress, has included India, Taiwan, and Thailand in its Monitoring List of major trading partners that “merit close attention” to their currency practices and macroeconomic policies.
- Other countries in the latest list comprise China, Japan, Korea, Germany, Italy, Singapore, and Malaysia.
UNDERSTANDING CURRENCY MANIPULATION
- Consider the laws of demand and supply. The value of a commodity rises when there’s considerable buying pressure and it tumbles when people start selling it en masse. It’s the age-old maxim that applies to almost everything you see around you, including currencies.
- So when the Reserve Bank of India shows an insatiable desire to buy the Indian currency by selling the US Dollar, then you are most likely to see an appreciation in its value. And when they start selling the rupee in exchange for dollars, then the value of our currency depreciates.
- In general, countries prefer their currency to be weak because it makes them more competitive on the international trade front.
- A lower currency makes a country’s exports more attractive because they are cheaper on the international market. For example, a weak Rupee makes Indian exports less expensive for offshore buyers.
- By boosting exports, a country can use a lower currency to shrink its trade deficit.
- A weaker currency alleviates pressure on a country’s sovereign debt obligations.
- After issuing offshore debt, a country will make payments, and as these payments are denominated in the offshore currency, a weak local currency effectively decreases these debt payments.
IMPACT ON INDIA
WAYFORWARD:
- India has traditionally tried to balance between preventing excess currency appreciation on the one hand and protecting domestic financial stability on the other.
- India being on the watch list could restrict the RBI in the foreign exchange operations it needs to pursue to protect financial stability. This comes when global capital flows threaten to overwhelm domestic monetary policy.
- The two most obvious consequences could be an appreciating rupee as well as excess liquidity that messes with the interest rate policy of the RBI.
- Other things remaining the same, government securities may also gain marginally as the RBI could choose OMOs to provide primary liquidity.
CONCLUSION:
- It will be a tall ask for India to be able to qualify all three conditions of the US Treasury to be tagged as a currency manipulator.
- Thus for India, it would not lead to any meaningful change in diplomatic and trade ties with the US. However, it may keep RBI somewhat guarded on aggressive forex intervention if capital flows continue to flood Indian shores, and thus could be mildly positive for the rupee.
JUST TO ADD IN YOUR KNOWLEDGE
EXCHANGE RATE
- The exchange rate is the price of one currency in terms of another currency.
- It often determines the affordability of buying or selling internationally. For instance, if one wants to buy a car produced in the U.S. that will involve two transactions: one, using rupees to buy dollars; two, using these dollars to buy the car.
- The exchange rate for any currency would be determined by the interplay of its demand and supply. For instance, if more Indians want to buy US goods, there would be a higher demand for the dollar relative to the rupee. This, in turn, would mean the dollar would be “stronger” than the rupee — and gain in strength as the demand increases.
- If demand falls, the dollar would depreciate relative to the rupee (or the rupee would appreciate relative to the dollar).
- Sometimes a central bank of a country intervenes to reduce wild fluctuations in the exchange rate. But excessive and undisclosed interventions are not considered fair.
- For instance, if China’s central bank buys dollars in the forex market, it can artificially weaken the yuan — and Chinese goods will then become more affordable (and competitive) in the international market.