On April 13, the US Treasury
Department delivered to Congress the semi-annual Report on Macroeconomic and
Foreign Exchange Policies of Major Trading Partners of the United States
Treasury, which found that six major trading partners warrant placement on
the ‘Monitoring List’ for their currency practices. Five of these countries — China, Germany, Japan, Korea and
Switzerland — were already on the list, India has been added this year. The US move and the higher rise in
March trade deficit created nervousness in the foreign exchange market on
Monday, with the rupee falling 29 paise against the US dollar to close at
65.49, a more than six-month low.
What does the report say?
Frequent intervention by the central bank in the foreign exchange
market means that India has increased its purchases of foreign exchange
over the first three quarters of 2017. Despite a sharp drop-off in purchases in
the fourth quarter, net annual purchases
of foreign exchange reached $56 billion in 2017, equivalent to 2.2% of the GDP.
The pick-up in purchases came amidst relatively strong foreign inflows, both of FDI and portfolio investment.
Notwithstanding the increase in intervention, the rupee appreciated by over 6%
against the dollar and by more than 3% on a real effective basis in 2017. India
had a significant bilateral goods trade surplus with the US, totalling $23
billion in 2017, but the current account is in deficit at 1.5% of the GDP and
the exchange rate is not deemed to be undervalued by the IMF.
So India met two of the three
criteria for the first time in this report — having a significant bilateral
surplus with the US and having engaged in persistent, one-sided intervention in
foreign exchange markets. US Treasury Secretary Steven T Mnuchin says in the
report, “We will continue to monitor and combat unfair currency practices,
while encouraging policies and reforms to address large trade imbalances.”
How do central banks intervene
and why?
Central banks intervene in the foreign exchange market to reduce
volatility in the exchange rate and often to build foreign exchange reserves or to manage these reserves. They
intervene to ensure that their currencies
are neither overvalued or undervalued. If the currency is overvalued, it can hurt a country’s
competitiveness in exports while an undervalued currency will have an impact on
inflation. For instance, when
the currency is appreciating, a central bank intervenes in the market by buying
foreign exchange — say, the USD or Euro or any other currency — which leads
to an increase in the supply of the local currency and in turn lowers its
value. To combat depreciation of the
currency, the central bank sells foreign exchange. It is also done to
manage expectations in the forex market. India’s central bank — the RBI has intervened in the market to build
the country’s reserves especially after 2013 when the rupee came under attack.
Since then reserves have risen.
Why has the RBI been buying
dollars?
The US report says India has
generally been a net purchaser of foreign exchange since late 2013, when the
RBI sought to build a stronger external buffer in the wake of large emerging
market outflows globally. Prior to 2013, intervention for several years had
generally been less frequent, and when it had occurred, it had been broadly
symmetric, as for example during 2007 and 2008, when the RBI engaged in both
purchases and sales of foreign exchange at various points in the midst of
volatile global financial markets. The RBI
has noted that the value of the rupee is broadly market-determined, with
intervention used only during “episodes of undue volatility”. Foreign
exchange intervention picked up in the first three quarters of 2017, in the
context of strong capital inflows, with FDI of $34 billion and foreign
portfolio flows of $26 billion over the first three quarters of the year.
On what basis is a country
named a ‘currency manipulator’?
The three pre-conditions for being named currency manipulator are: a trade
surplus of over $20 billion with the US, a current account deficit surplus of
3% of the GDP, and persistent foreign exchange purchases of 2% plus of the GDP
over 12 months. All three apply to India. “While there has not been a
dramatic increase in trade surplus with the US, the RBI accumulated reserves by
absorbing the inflows into domestic capital markets. This caution seems
unwarranted considering that India runs a trade deficit overall, based on 36
currency REER (real effective exchange rate), the rupee is still overvalued,”
said Abhishek Goenka, CEO, IFA Global.
What about the rupee? Will
this report of the US Treasury impact the currency?
The rupee fell 29 paise against
the US dollar to close at 65.49 on Monday. However, forex dealers don’t expect
a sharp fall as the RBI then props up the rupee by selling dollars.
Notwithstanding the pick-up in intervention, the rupee appreciated 6.4% against
the dollar over 2017, while the real effective exchange rate also continued its
general uptrend from the last few years, appreciating by 3.1%. In its most
recent analysis, the IMF maintained its
assessment that the rupee is moderately overvalued. The RBI’s most recent annual report assessed
the rupee to be “closely aligned to its fair value over the long term”.
How have India’s foreign
exchange reserves moved?
According to latest RBI data,
released last Friday, India’s forex reserves rose by $503.6 million to touch a
record high of $424.86 billion in the week ended April 6, 2018. Of this,
foreign currency reserves were $399.776 billion. Direct intervention has supported
a steady increase in foreign exchange reserve levels. At the end of 2013,
foreign currency reserves were $268 billion, or 2.3 times short-term external
debt, 6 months of import cover, and 14% of the GDP.
How are analysts viewing this
Monitoring List of the US Treasury?
Indranil Sen Gupta of Bank of
America Merrill Lynch Global Research says, “We continue to expect the RBI to
recoup foreign exchange reserves if it can, despite being put on the US
Treasury Report’s currency manipulator watch list. It should continue to pursue
an asymmetrical policy of buying forex when the dollar weakens and allowing Rs
65-66 per dollar when it strengthens.” The RBI’s
forex reserves are inadequate: import cover, at 11 months, is running well
below the pre-global financial crisis level of 14 months, share of
portfolio investments has jumped to 120% of forex reserves from pre-crisis
level of 70%. “Second, we see RBI forex intervention at $15bn/ 0.6% of the GDP
in FY19 — which is well below 2% of the GDP required to be named currency
manipulator — with the current account deficit set to rise to 1.9% of the GDP
when portfolio inflows are slowing,” Merrill Lynch says.
Credit: Indian Express Explained
(http://indianexpress.com/article/explained/simply-put-why-india-is-on-us-currency-monitoring-list-5140032/)
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