India is not using currency to gain unfair advantage
The US treasury department’s latest assessment of currency practices and macroeconomic policies has kept India on the monitoring list along with countries such as China, Japan, and Germany. The department is required to assess whether major trading partners are manipulating their exchange rate to gain unfair competitive advantage and preventing effective balance of payments adjustment. It considers three criteria in this context: A bilateral trade surplus with the US in excess of $20 billion over a 12-month period; a current account surplus in excess of 2 per cent of gross domestic product (GDP) over a 12-month period; and persistent one-sided intervention in the foreign exchange market, resulting in a net purchase of foreign currency worth over 2 per cent of GDP. India met two of the three conditions — persistent one-sided intervention in the foreign exchange market and a significant trade surplus during the period of review.
The suggestion by the US that India is manipulating its currency to gain an unfair advantage is absolutely incorrect. According to the report, India had a goods trade surplus with the US worth $24 billion in 2020, which is not very different from recent years. It also ran a services surplus worth $8 billion during the year. India intervened in the foreign exchange market significantly in 2020 and accumulated reserves worth about 5 per cent of GDP. It also registered a current account surplus of 1.3 per cent of GDP in 2020. While the trade surplus with the US was similar to recent years, it is important to understand the context in which the Reserve Bank of India (RBI) intervened in the currency market and why India registered a current account surplus — its first since 2003-04.
The RBI’s market intervention was essentially driven by developments in global markets. It was selling foreign currency in the early part of 2020 to avoid a sharp depreciation in the rupee. However, as the risk appetite returned, a sharp increase in capital flows forced the Indian central bank to absorb excess foreign currency. In the absence of intervention, the rupee could have appreciated significantly, potentially resulting in macroeconomic imbalances. Capital inflows were largely driven by monetary accommodation provided by large central banks, particularly the US Fed. The Fed’s balance sheet has nearly doubled since the beginning of the crisis. It is also worth noting that faster than expected economic recovery in the US has started pulling capital out of emerging markets. Lower reserves and an excessively overvalued currency could have put India in a vulnerable position like the taper tantrum episode. India witnessed a near-currency crisis in 2013 as capital moved out of emerging markets.
Further, India’s current account surplus was not driven by its currency market intervention but a contraction in imports owing to Covid-related disruptions. The Indian economy is expected to have contracted by 8 per cent in 2020-21. India normally runs a current account deficit, which means it is a net importer of goods and services from the rest of the world. This clearly shows that it’s not manipulating currency to gain an unfair advantage. The US treasury department itself notes that India’s disclosure of currency market intervention has been exemplary. Thus, the US government should avoid putting India on a mechanically produced monitoring list. The Indian policy establishment should also work with the US to convey its position more effectively and avoid any unfavourable action on the trade front.