US frowns over India’s forex policies
In a recent report to Congress, the US Treasury department has included India along with five other nations for their foreign exchange and macroeconomic policies.
Why are India’s currency practices under the US watch?
India meets two of three criteria laid out for inclusion in the monitoring list. These are large trade surplus with US and excessive purchases of dollars. India’s bilateral merchandise trade surplus with US in 2017 at $23 billion was higher than the $20 billion benchmark used for assessment, and net purchases of foreign currency was 2.2% of gross domestic product (GDP), higher than the 2% cut-off. India did not meet the third criteria, which is having current account surplus of at least 3% of the GDP. India’s current account is in deficit.
What is the report about?
The US department of Treasury releases a semi-annual report to the Congress on international economic and exchange rate policies. The report highlights the currency practices adopted by major trading partners of the US. Once a country named in the monitoring list, will remain included for at least two consecutive reports. “This Report, by monitoring where unfair currency practices may be emerging and encouraging policies and reforms to address large external surpluses, represents an important component of the (US) Administration’s strategy for securing a stronger America and a more robust and fair global economy,” it said.
Why did RBI intervene in forex market in 2017?
In 2017, rupee gained 6.3% against the dollar mainly on due to good inflows both of foreign direct investment and portfolio investment. This led to the active intervention of the central bank in the market to sterilize dollar flows. Accordingly, forex reserves rose and are currently at an all-time high of nearly $425 billion. RBI’s stated policy has been that it intervenes in forex market to curb undue volatility. But at the same time, learning from the so-called Taper Tantrum episode in 2013, where the US first indicated that it will be normalising monetary policy, it would be only fair for the central bank to be mindful of the need to increase forex reserves as guard against sudden outflow, currency dealers said. This argument also holds true in the context of India’s rising external debt.
What does the report mean for India?
For the country, this could be reputation risk, especially given the context of US President Donald Trump’s rhetoric of imposing trade barriers. Experts believe the probability of India being tagged as currency manipulator is low. This is because China, despite a massive trade surplus with the US, large current account surplus and known for its exchange rate management, is still only in the monitoring list. However, Indian authorities may remain watchful of tackling the issue while keeping in mind the need to protect domestic financial stability.
What does this mean for the rupee?
While the report has no impact on the rupee, the Reserve Bank of India (RBI) may choose to be cautious of intervening in the market, especially when there is surge in inflows. Currently, the rupee is on depreciating mode and hence the RBI’s need to intervene is ruled out. External volatility, with rise in US bonds yields, oil prices, geopolitical concerns and a threat of trade war has led to the dollar strengthening and the rupee weakening. Slowing inflows into local financial markets and the widening current account deficit have also contributed to the weaker rupee. So far in 2018, the rupee has weakened 2%.