Red Lights in Washington

Raman Swamy

What is "Currency Manipulation"? Why is the United States upset with India for going on a dollar-buying spree?

The Reserve Bank of India has been steadily purchasing the US currency on the foreign exchange market. Some estimates say that RBI has mopped up more than 40 Billion Dollars in the last ten months alone.

This comes perilously close to the red line set by the US Treasury Department—any country which accumulates dollar reserves exceeding 2 percent of its GDP is put on the "watch-list" and could be declared a "currency manipulator".

The red lights have already begun flashing in Washington. India's stock of dollars has crept up to over 400 billion dollars which is about 1.8 percent of the current GDP.

Is there a risk that the US Treasury Department might formally declare India to be a currency manipulator? What will be consequences if that happens?

India and America are supposed to be Best Friends Forever (BFF). Just recently, Rex Tillerson, the head of the State Department, spoke fondly about a 100-year strategic relationship. Why is another department of the Trump Administration virtually accusing India of "unfair practices" in money matters?

Here is what the US Treasury has said in a report released in October 2017—it has decided to "closely monitor India's currency practices" because it has come to light that there has been an unusual increase in the "scale and persistence" of India's foreign exchange purchases.

According to those who understand the motives behind complex forex transactions by central banks, India's main motive is to keep the rupee exchange rate from rising too high.

In international trade, it is better to have a relatively weak and cheap currency. If the value of country's domestic currency surges, it could lead to economically harmful consequences. For instance, exports will become difficult if the rupee rate is too high vis-a-vis other currencies.

Forex analysts say India's dollar buying frenzy is a symptom of the desperate bid to prevent the rupee from becoming too expensive, especially after the demonetisation exercise a year ago.

In fact, the hectic activity began from January this year. India came under the spotlight when currency purchases soared much higher than the normal 10 billion dollars in calendar year 2016.

The US Treasury Department's report observes: "Over the first half of 2017, there has been a notable increase in the scale and persistence of India's net foreign exchange purchases. We will be closely monitoring India's foreign Exchange and macroeconomic policies".

Evidently, the Reserve Bank intensified the buying of foreign currencies from January this year after a surge in capital inflows into India's stocks and bonds sent the rupee appreciating to its strongest in two years against the US dollar.

As a result, India's foreign reserves rose to an all-time high of 402.51 billion dollars in September 2017. Although the government portrayed this as a big achievement, in reality very high forex reserves are a mixed blessing.

Robust foreign reserves can help protect a country against economic shocks and sudden outward flight of capital. But if the process of bolstering up such reserves hurts other countries then the label of "currency manipulator" could prove disastrous.

As far as the United States is concerned the present administration has warned any country which indulges in unfair currency practices, runs the risk of having trade sanctions imposed. China is high on the list of countries that are officially being watched carefully.

Even without being actually labelled a "currency manipulator", being mentioned in the Treasury Department's October report as a country being monitored could cramp India's freedom in managing the rupee. To avoid this, the RBI will now be forced to go slow and reduce its foreign exchange purchases.

However, analysts say that doing so at a time when capital inflows are still strong, could be costly for the economy, as its domestic currency may become expensive and hurt the country's competitiveness. India is clearly caught in a dilemma.

Vol. 50, No.28, Jan 14 - 20, 2017