Indian policymakers have to be sensitive, without actually overreacting, to the risk that Donald Trump may move from rattling the sabres to actually using them. Illustration: Jayachandran/Mint
The Indian government reported last week that the trade deficit with the rest of the world nearly doubled in the financial year ended 31 March. The US Treasury Department said a few hours later that it would be adding India to the list of countries that it considers as potential currency manipulators. All this comes against the backdrop of growing global trade tensions. It is important to recognize that India has been put on a watch list rather than being actually accused of manipulating its exchange rate to hurt US interests. However, the mere fact that India is on the watch list now could restrict the Reserve Bank of India (RBI) in the foreign exchange operations it needs to pursue to protect financial stability, especially when global capital flows threaten to overwhelm domestic monetary policy.
India is now giving company to China, Japan, Germany, South Korea and Switzerland. A country such as India with a widening external deficit is an unlikely candidate for being described as a currency manipulator. The Indian rupee has actually appreciated against the US dollar in real terms in recent quarters, which is calculated after taking into account the rise in domestic prices. India does try to manage the exchange rate through sterilized intervention, but is by no stretch of imagination a currency manipulator. “Given that Indian foreign exchange standards are ample by common metrics, and that India maintains some controls on both inbound and outbound flows of private capital, further reserve accumulation does not seem necessary,” the US Treasury has said in its report. The Indian central bank added $56 billion to its foreign exchange reserves in 2017.
How are countries accused of currency manipulation by the US Treasury actually identified? There are three parameters that are used, sometimes unthinkingly. First, a country has to run a significant trade surplus of over $20 billion with the US. Second, it is judged not by the amount of currency intervention but whether such an operation is a one-sided attempt to keep the exchange rate down, measured in terms of additional foreign exchange reserves as a percentage of gross domestic product (GDP). Third, a country should have a large current account surplus with the rest of the world. How does India fare on these three fronts?
India does have a $23 billion trade surplus with the US, though that is dwarfed by the $375 billion trade surplus that China runs with the US. Mexico, Japan and Germany have far bigger bilateral trade surpluses. The net foreign exchange purchases by the RBI in 2017 amounted to 2.2% of GDP, which is close to what Thailand, Taiwan and Switzerland have done. And India is the only one of the countries on the US Treasury list that has a current account deficit with the rest of the world. Countries such as Thailand or Mexico were considered far more likely than India to be identified as potential currency manipulators.
Do Indian policymakers have to worry? They should not in normal times. The mechanical way in which the US Treasury interprets its three main parameters for identifying currency manipulation is almost scandalous. Also remember that the US has not yet formally accused China — with its notorious mercantilism — as a currency manipulator. US President Donald Trump had promised during his election campaign to treat China like a currency manipulator. If a country such as China with a massive bilateral trade surplus with the US, a large current account surplus with the rest of the world, and historically unprecedented management of its exchange rate is still only on the watch list, then the chances of India being actually termed a currency manipulator are slim.
The problem is that these are not normal times. Trump is merrily charging into a trade war that has much of the world on tenterhooks. He believes American workers are getting pushed into a corner because of trade partners who get preferential treatment in free trade agreements, or who strategically use trade barriers, or who keep their exchange rates artificially low to promote exports to the US. The new list released by the US Treasury needs to be seen against this background.
Indian policymakers have to be sensitive, without actually overreacting, to the risk that Trump may move from rattling the sabres to actually using them. India has traditionally tried to balance between preventing excess currency appreciation on the one hand and protecting domestic financial stability on the other. Much now depends on how the Indian government and the Indian central bank respond to the implicit US threat — but the two most obvious consequences could be an appreciating rupee as well as excess liquidity that messes with the interest rate policy of the RBI.
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