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The US 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 India’s addition 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 US Treasury. The three benchmarks it uses are:
India, the report finds, meets the first and third criteria.
India’s bilateral trade surplus (merchandise and services) with the US stood at $28 billion in 2017, according to the US Treasury report. The surplus is actually marginally lower than the $30.8 billion recorded in 2016, shows data available on the website of the US Trade Representative.
In fact, data from the US 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 US Dollar, rather than depreciating. The appreciation came against the backdrop of significant capital inflows and a broad weakness in the US Dollar last year.
As such, while India may breach the benchmark of a $20-billion trade surplus with the US, 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 (IMF), and the US 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.
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.
The wide trade gap will mean that India will see its current account balance deteriorate in 2017-2018. Rating agency ICRA expects the current account deficit to more than triple to $ 47-50 billion, or about 1.9 percent of GDP, in 2017-2018.
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 US Treasury report acknowledges that there is limited probability of India running a large current account surplus.
The third criteria used by the US 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
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 normalise monetary policy. India, in 2013, saw its currency plummet when the US 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 US Treasury Department argues that India’s forex reserves are now adequate.
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 US.
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.
(This article has been published in association with BloombergQuint.)
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