Brain Booster for UPSC & State PCS Examination (Topic: Currency Manipulation)

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Topic: Currency Manipulation

Currency Manipulation

Why in News?

  • The US Treasury Department’s semiannual report on the macroeconomic and foreign exchange policies of major trading partners has put India on the watch list of countries being monitored for currency manipulation. This comes after the Indian central bank stepped up purchases of foreign currency as portfolio flows surged in the second half of the year.

Currency Manipulation

  • This is a label given by the US government to countries it feels are engaging in “unfair currency practices” by deliberately devaluing their currency against the dollar.
  • The practice would mean that the country in question is artificially lowering the value of its currency to gain an unfair advantage over others.
  • This is because the devaluation would reduce the cost of exports from that country and artificially show a reduction in trade deficits as a result.
  • The US Treasury department’s decision to put India back on the currency manipulator’s watchlist could keep RBI somewhat “guarded on aggressive forex intervention”
  • India was last included in the currency watchlist in October 2018, but removed from the list that came out in May 2019.
  • The designation of a country as a currency manipulator does not immediately attract any penalties, but tends to dent the confidence about a country in the global financial markets.

Criteria which Led to Targeting India

  • The US Treasury uses three benchmarks to judge currency manipulators:
  1. A bilateral trade surplus with the U.S. of more than $20 billion.
  2. A current account surplus of at least 3% of GDP.
  3. Net purchases of foreign currency of 2% of GDP over a 12-month period.
  • India breached the first and the third benchmarks. On the second, on a four-quarter basis, the country’s current account surplus remained below the threshold level.
  • “India for several years has maintained a significant bilateral goods trade surplus with the United States, which totalled $22 billion in the four quarters through June 2020,” the report said. The economy’s first four-quarter current account surplus since 2004 stood at 0.4% of GDP over the year to June 2020, it said.
  • According to the report, net purchases of foreign currency added up to 2.4% of GDP. While the department acknowledged the RBI’s transparency in publishing data on intervention, it called for the central bank to allow the rupee to adjust based on fundamentals.

Global Liquidity Surplus

  • The new watch list also names China, Japan, Korea, Germany, Italy, Singapore, Malaysia, Taiwan and Thailand. Switzerland and Vietnam have been declared as outright currency manipulators, the first countries so designated since China (in 2019).
  • India’s re-entry into the watch list is not entirely surprising amid massive forex intervention by the Reserve Bank of India (RBI) this year.
  • The expected balance of payments surplus in FY21 is at least $90 billion.
  • The gush of global liquidity has led to search for carry among foreign investors as risk appetite improved.
  • This has meant strong inflows into emerging economies like India.
  • So far this financial year, foreign portfolio flows, led by equities, have surged to $21.5 billion compared to $7.8bn a year ago while patchy and bulky FDI flows also boosted the capital account.

RBI’s Dilemma

  • Amid consistent foreign flows, the external sector continues to pose the problem of plenty. The RBI so far has been deflecting massive capital inflows by intervening aggressively to prevent the rupee’s appreciation amid competitiveness and currency overvaluation concerns.
  • The aggressive intervention in spot and forward FX markets has led to the rupee being an underperformer in the emerging markets grouping (the worst performer in emerging Asia in 2020), with RBI possibly treating relative rupee weakness as an automatic stabilizer for the growth downturn.
  • Also, letting the rupee strengthen technically would have constituted a tightening of monetary conditions that offsets interest rate cuts and liquidity injections.