US Treasury Department’s recent semi-annual report has warranted India to be placed on the ‘Monitoring List’ for currency practices.
The move is largely unjustified as RBI interventions were on account of a surplus capital account and not for undervaluing the Rupee.
Why has India intervened in foreign exchange markets?
India has been frequently intervening in foreign exchange markets through RBI – which means that it is purchasing more foreign exchange lately.
The Concept - RBI pumps in Indian Rupee and buys foreign currency from the international markets – which increases rupee supply internationally.
This reduces the demand for rupee and thereby reduces the rupee exchange rate, which helps in arresting any upswing in rupee value.
It is to be noted that a strong currency would make exports costlier and create losses for export dependent local businesses.
Contrarily, when there is a big depreciation of rupee, India’s imports will become expensive and lead to domestic inflation.
In such a scenario, the RBI sells its foreign exchange reserves and drains out rupee liquidity internationally, which will push the exchange rates upwards.
Thus, the interventions are buffer mechanisms in RBI’s arsenal to ensure that the currency neither gets overvalued nor gets undervalued.
Current Stats - Net annual purchases of foreign exchange reached $56 billion in 2017, which is equivalent to 2.2% of the GDP.
These interventions were to ease a strong Rupee Rally (appreciation) in the backdrop of a massive inflow of FDI and portfolio investments.
But despite these intervention, rupee appreciated by over 6% against the dollar and by more than 3% on a real effective basis in 2017.
Significantly, India’s Forex reserves have been continuously rising (presently $424.86 billion) due to frequent intervention since 2013.
Regulations - Value of free-floating currency isn’t supposed to be tampered with except in exceptional cases (rapid fluctuations), because appreciation and depreciation are balancing mechanisms in international trade.
IMF would’ve usually deemed the currency of counties that undertake such interventions as undervalued, but it has refrained currently as India has a ‘Current Account Deficit’ (CAD) that is as high 1.5% of its GDP.
Notably, RBI maintains that the value of the rupee is broadly market-determined and that interventions are only when there is undue volatility.
What does the US report say?
India had a significant bilateral goods trade surplus with the US, which totals to $23 billion in 2017.
US has 3 criterions based on which it placing a country in the ‘Monitoring List’ for currency practices. They are -
Bilateral trade surplus of over $20 billion with the US
Frequent interventions in the Forex Market
IMF’s contention of that the currency is being undervalued
Hence, as India meets 2 of the 3 stated aspects, the US Treasury Department has warranted placing India on the aforementioned “Monitoring List”.
Notably, 5 other countries namely - China, Germany, Japan, Korea and Switzerland are already on the list.
The US has maintained that the list is to aid in monitoring and combating unfair currency practices and encourage policies to address trade imbalences.
Is the US move justified?
India does indeed have a trade surplus with the US, but unlike China, it still has a large trade deficit overall – which implies that Rupee is still overvalued.
A recent assessment by the IMF has also held that the rupee is actually moderately overvalued and ‘closely aligned to its fair value over the long term’.
The accumulated foreign exchange reserves were largely due inflows into the capital markets and hence India doesn’t qualify as a currency manipulator.
Also, RBI is projected to merely purchase 0.6% of GDP as Forex, which is well below the IMF ceiling (2% of GDP) for being labelled a currency manipulator.
How does the future look?
RBI’s forex reserves now covers only 11 months of imports, which is actually below pre-2008 (global financial crisis) level of maintaining a 14 month buffer.
Also, the Current Account Deficit (CAD) is set to rise to 1.9% of the GDP.
More significantly, share of portfolio investments has jumped to 120% of forex reserves from pre-crisis level of 70% - which calls for jacking up reserves.
US listing has currently caused the rupee to fall sharply by 29 paise against the US dollar to close at 65.49 in one day.
However, forex dealers don’t expect a sharp fall as the RBI then props up the rupee by selling dollars from its reserves.
Hence, experts opine that RBI will continue with its interventionist approach at appropriate times, despite being placed on the US watch list.
