Indian five hundred rupee banknotes are arranged for a photograph in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

Is India Really A Currency Manipulator? 

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The U.S. Treasury’s semi-annual foreign exchange policy report is typically watched for statements on the Chinese currency. This year’s report, however, is more notable for the addition of the Indian currency to the‘watch list’ of nations that may be intervening excessively in their foreign exchange markets and distorting trade flows.

India was added to the list because it meets two of the three criteria laid down by the U.S. Treasury. It uses three benchmarks:

  • A bilateral trade surplus with the U.S. of more than $20 billion.
  • A current account surplus of at least 3 percent of GDP.
  • Net purchases of foreign currency of 2 percent of GDP over a 12-month period.

India, the report finds, meets the first and third criteria.

Trade Surplus With The U.S.

India’s bilateral trade surplus (merchandise and services) with the U.S. stood at $28 billion in 2017, according to the U.S. Treasury report. The surplus is actually marginally lower than the $30.8 billion recorded in 2016, shows data available on the website of the U.S. Trade Representative.

On merchandise trade, India’s trade surplus with the U.S. stood at $23 billion in 2017, comparable with the $24 billion in 2016. In fact, data from the U.S. Commerce Department website shows that the merchandise trade surplus has been above $20 billion since at least 2013.

It is also worth noting here, that in 2017, the Indian rupee actually appreciated against the U.S. Dollar, rather than depreciated. The appreciation came against the backdrop of significant capital inflows and a broad weakness in the U.S. Dollar last year.

As such, while India may breach the benchmark of a $20-billion trade surplus with the U.S., neither the change in the trade surplus nor the currency movement suggests that India was manipulating its currency for trade gains in 2017--the year under review.

The Indian currency is also not seen as undervalued by the International Monetary Fund and U.S. Treasury’s report acknowledged as much. The 36-country Real Effective Exchange Rate index compiled by the Reserve Bank of India was at 117 as of March 2018, suggesting, if anything, that the Indian currency is marginally overvalued.

Current Account Surplus

Ironically, the report came hours after India reported that its merchandise trade deficit jumped to $87 billion in 2017-18 compared to $47.7 billion the previous year.

India’s exports grew 9.8 percent in the 12 months ended March 2018, after a growth of 5.2 percent in the 2016-17. And, this, is at a time when global demand has been strong. According to the World Trade Organisation, global trade grew at its strongest pace in six years in 2017 at 4.7 percent.

The wide trade gap will mean that India will see its current account balance deteriorate in 2017-18. Rating agency ICRA expects the current account deficit to more than triple to $47-50 billion, or about 1.9 percent of GDP, in 2017-18. In the previous financial year, India had a current account deficit of $15 billion.

The last time India posted a current account surplus of any magnitude was in the early 2000s.

The U.S. Treasury report acknowledges that there is limited probability of India running a large current account surplus. “The IMF projects the current account deficit to widen to about 2 percent of GDP over the medium term as domestic demand strengthens further and given the rebound in commodity prices,” the report said.

Forex Intervention & Reserves

The third criteria used by the U.S. Treasury department is the only real reason why India has been included in the watch list of currency manipulators.

Large inflows of foreign capital into India over the last couple of years has led to increased intervention in the forex markets in India. The RBI conducted net purchases of foreign exchange to the tune of $56 billion in 2017, including activity in the forward market, said the report. This is equivalent to about 2.2 percent of GDP--marginally above the Treasury Department’s threshold.

Intervention, via purchase of foreign exchange in the spot and forward market, have risen mostly because of the pick-up in foreign flows. The country has received foreign direct investment of $34 billion and foreign portfolio flows of $26 billion over the first three quarters of the year, the report said.

While the RBI’s stated stance is that it steps in to curb excess volatility in the foreign exchange market and not to manage the rate of exchange, there are two reasons for the increased intervention.

One perceived reason is the need to ensure that India has adequate forex reserves to deal with a situation where there are large outflows. A scenario like this could emerge as developed market central banks normalize monetary policy. India, in 2013, saw its currency plummet when the U.S. Federal Reserve first suggested normalisation of monetary policy. While India’s fundamentals have improved since then, the memory of falling reserves, which led to the RBI announcing a special scheme to draw-in foreign deposits, is probably still fresh in the minds of policymakers.

At $425 billion, the U.S. Treasury Department argues that India’s forex reserves are now adequate.

Given that Indian foreign exchange reserves are ample by common metrics, and that India maintains some controls on both inbound and outbound flows of private capital, further reserve accumulation does not appear necessary.
U.S. Treasury Department Foreign Exchange Policy Report

While there is no doubt, that India is now comfortable on forex reserves, the Treasury Department’s own data shows that its reserve accretion in 2017 and level of reserves is comparable to the other trading partners of the U.S.

The report also looks at adequacy of reserves slightly differently from the RBI by measuring it mostly against short-term debt. However, in a 2015 paper, RBI staffers had pointed out that India may need to consider factors other than the traditional metrics of forex reserve adequacy. One such factor is potential volatility of foreign portfolio inflows, since such flows are a significant source of financing India’s current account deficit.

Finally, while supporting the employment generating export sector is not the RBI’s mandate, it would be justified in keeping an eye out on that aspect too. As a flexible inflation targeting central bank, growth is still broadly part of the RBI’s mandate. To the extent that the currency impacts exports, which in turn impacts growth and employment, the Indian central bank would be justified in ensuring that the value of the currency is not wildly out of line with fundamentals just because of a surge in capital flows.

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