Mumbai: The US treasury department’s move to place India under the currency manipulator watchlist is likely to create additional headwinds for the Reserve Bank of India (RBI) to shore up the country’s foreign exchange reserves, and also halt the rupee’s sharp appreciation on the back of strong foreign fund inflow.
In its report Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States, the treasury Wednesday said 10 economies — China, Japan, Korea, Germany, Italy, Singapore, Malaysia, Taiwan, Thailand and India — warrant placement on its ‘Monitoring List’, and merit close attention as these countries are suspected to be taking measures to devalue their currencies against the dollar. Moreover, it labelled Switzerland and Vietnam as currency manipulators.
The report observed that a number of countries have conducted foreign exchange market intervention in a persistent, one-sided manner that exceeds treasury criteria pursuant to the Trade Facilitation and Trade Enforcement Act of 2015.
India, the report said, along with three other countries intervened in the foreign exchange market in a sustained, asymmetric manner.
Rupee is the worst performing currency in Asia in 2020 as it depreciated 2.8 per cent against the dollar due to heavy RBI intervention amid robust inflows.
The department had put New Delhi in the same list earlier in May 2018, but removed it last year.
The India issue
New Delhi has violated the parameters that are tracked by the US treasury department to identify currency manipulators. The first is that the trade surplus with the US should be less than $20 billion.
“India for several years has maintained a significant bilateral goods trade surplus with the United States, which totaled $22 billion in the four quarters through June 2020,” the report said.
The second bound is that currency intervention must be less than 2 per cent of the country’s GDP.
The report noted that India’s net purchases of foreign exchange accelerated notably in the second half of 2019, and following sales during the initial onset of the pandemic, India sustained net purchases for much of the first half of this year.
“This pushed net purchases of foreign exchange to $64 billion, or 2.4% of GDP, over the four quarters through June 2020… Treasury encourages the authorities to limit foreign exchange intervention to periods of excessive volatility, while allowing the rupee to adjust based on economic fundamentals,” the report said.
An Indian economist who didn’t wish to be named told ThePrint, “At the time of preparing the report in June, India’s currency intervention was 2.4 per cent of GDP which is now almost close to 4 per cent.”
The third parameter is considered to be breached when the current account surplus is more than 2 per cent of GDP.
India recorded a current account surplus of $19.8 billion, which was 3.9 per cent of GDP, for the first quarter of the current fiscal as compared to 0.1 per cent surplus in the preceding March quarter of 2019-20.
The huge surplus in the current account in Q1 of 2020-21 was on account of a sharp contraction in the trade deficit to $10 billion due to steeper decline in merchandise imports relative to exports on a year-on-year basis. While India is expected to post a record current account surplus for this fiscal, the situation is expected to reverse next year as imports pick up.
RBI’s FX mop up
India’s foreign exchange reserves swelled to over $100 billion in the current financial year on the back of the RBI’s aggressive intervention policy.
The central bank has mopped up dollars which prevented the currency from appreciating sharply. A sharp appreciation of the currency serves the exporters negatively.
“Given RBI has been aggressively buying FX both in spot and futures amid massive capital flows, this development (manipulator watchlist) was not a surprise as such,” said Madhavi Arora, lead economist, Emkay Global.
“While this doesn’t change the diplomatic or trade dynamics of India with the US as such, this could keep RBI somewhat guarded on aggressive FX intervention. A slightly tone-down stance on FX could be INR positive at the margin,” Arora said.
As inflows from foreign investors remain healthy, currency experts had expected RBI to beef up its dollar purchase to keep the rupee under check.
Rupee had depreciated 3.4 per cent against the dollar in the second half of 2019, and then another 5.5 per cent during the first half of 2020.
BoFA Securities last month raised RBI’s foreign exchange intervention forecast by $6 billion to $77 billion for the current fiscal.
“This follows an upward revision of our current account surplus forecast by 20bp to 1% of GDP. The trade deficit worsened to US$8.7bn in October from US$2.7bn in September as exports fell again, led by oil. Imports, however, continued to decline, but at a slower pace, as both gold and non-oil, non-gold imports performed relatively better,” the BoFA report said.
The latest US treasury report noted that rupee has diverged somewhat from peer currencies amid RBI intervention. It also urged the Indian authorities to allow the exchange rate to move to reflect economic fundamentals and limit foreign exchange intervention to circumstances of disorderly market conditions.
“India can also leverage the recovery period to pursue structural reforms that will open its market further to foreign investment and trade, including foreign portfolio investment in Indian sovereign and sub-sovereign bonds, thereby fostering stronger long-term growth,” the US report added.
How RBI reacts to the observation, and whether this could have wider geopolitical ramifications under President-elect Joe Biden, remains to be seen.
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