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Currency Manipulation: Is India Guilty of it?

Why Is Currency Important to Trade?

Currency is important to trade because trade happens through the exchange of money, currency can be as important an influence on trade as the qualities of the traded goods or services themselves.

When governments intervene in currency markets to subsidize their exports, they violate the principles of free trade and force the market to ignore normal pressures of supply and demand.

Free trade supports U.S. exports and American jobs, but free trade in goods and services requires free trade in currencies.

Government intervention in currency markets distorts trade flows and undermines free trade agreements.

How Does a Country Manipulate Its Currency?

Currency manipulation is a policy used by governments and central banks of some of America’s largest trading partners to artificially lower the value of their currency (in turn lowering the cost of their exports) to gain an unfair competitive advantage.

Simply explained, in order to weaken its currency, a country sells its own currency and buys foreign currency – usually U.S. dollars. Following the laws of supply and demand, the result is that the manipulating country reduces the demand for its own currency while increasing the demand for foreign currencies.

How Do We Know a Country Has Manipulated Its Currency?

As it turns out, currency manipulation is not that easy to identify. As one Wall Street Journal blog post puts it, “Currency manipulation is not like pornography—you don’t know it when you think you see it.” Policy action that favourably affects a country's exchange rate—making exports more competitive—is not in itself evidence of currency manipulation. You also have to prove that the value of the currency is being held artificially below its true value. What’s the true value of a currency? That’s not easy to determine, either.

In general, countries prefer their currency to be weak because it makes them more competitive on the international trade front. A lower currency makes a country's exports more attractive because they are cheaper on the international market. For example, a weak U.S. dollar makes U.S. car exports less expensive for offshore buyers. Secondly, by boosting exports, a country can use a lower currency to shrink its trade deficit. Finally, a weaker currency alleviates pressure on a country's sovereign debt obligations. After issuing offshore debt, a country will make payments, and as these payments are denominated in the offshore currency, a weak local currency effectively decreases these debt payments. 

Countries around the world adopt different practices to keep the value of its currency low. The rate on the Chinese yuan is set each morning by the People's Bank of China. The central bank does not allow its currency to trade outside of a set band over the next 24-hours, which prevents it from any significant intraday declines. 

A more direct form of currency manipulation is intervention. After the appreciation of the Swiss franc during the financial crisis, the Swiss National Bank purchased up large sums of foreign currency, namely USD and euro's, and sold the franc. By moving its currency lower through direct market intervention, it hoped Switzerland would increase its trade position within Europe. 

The International Monetary Foundation (IMF) and the World Trade Organization (WTO) have provisions prohibiting the use of currency manipulation to gain trade advantages. Based on IMF principles, a three-part test can be used to clearly identify a currency manipulator within existing or future trade agreements:

Did Country X have more exports than imports (an account surplus) over a set six-month period?Did Country X add to its foreign exchange reserves over that same six-month period?

Are Country X’s foreign exchange reserves more than sufficient (i.e. over three months’ normal imports)?

Once on the Monitoring List, an economy will remain there for at least two consecutive reports “to help ensure that any improvement in performance versus the criteria is durable and is not due to temporary factors,” according to the US treasury department.

The administration will also add and retain on the Monitoring List any major US trading partner that accounts for a “large and disproportionate” share of the overall US trade deficit, “even if that economy has not met two of the three criteria from the 2015 Act”.

Do Monetary Policy and Quantitative Easing Fall under This Test?

No. The currency rules recommended by leading economists would NOT affect monetary policy. The test is narrowly targeted to capture the most egregious policy – direct intervention – and in no way restricts the ability of a country to engage in independent monetary policies like quantitative easing.

What Happens When a Country Manipulates Its Currency? 

American-made products can compete anywhere in the world within a free market. But when countries manipulate currencies and unfairly lower the cost of their exports, markets are distorted in three significant ways, damaging the U.S. economy and costing America jobs.

U.S. exports to Country X become more expensive

Country X’s weaker currency increases the cost of U.S. exports, making them less attractive to consumers in Country X, causing reduced U.S. exports and a loss of U.S. jobs.

Country X’s exports to the U.S. have an unearned competitive advantage

Country X’s weaker currency lowers the cost of Country X’s exports, making them more attractive than American-made goods, causing fewer sales of U.S. products and a loss of U.S. jobs.

U.S. exports to all countries become less competitive

Country X’s weaker currency increases the cost of U.S. exports in all global markets, making them less attractive to consumers the world over, causing reduced U.S. exports and a loss of U.S. jobs.

Why has the US put India on its currency watchlist?

The U.S. Treasury Department’s semi-annual report on the macroeconomic and foreign exchange policies of major trading partners has put India on the watchlist 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.

The US Department of the Treasury Office of International Affairs, in its latest report to the US Congress, has included India, Taiwan and Thailand to its Monitoring List of major trading partners that “merit close attention” to their currency practices and macroeconomic policies.

Other countries in the latest list comprise China, Japan, Korea, Germany, Italy, Singapore, Malaysia.

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.

Why is India back in the Monitoring List again?

India, which has for several years maintained a “significant” bilateral goods trade surplus with the US, crossed the $20 billion mark, according to the latest report. Bilateral goods trade surplus totalled $22 billion in the first four quarters through June 2020.

Based on the central bank’s intervention data, India’s net purchases of foreign exchange accelerated notably in the second half of 2019. Following sales during the initial onset of the pandemic, India sustained net purchases for much of the first half of 2020, which pushed net purchases of foreign exchange to $64 billion–or 2.4% of GDP–over the four quarters through June 2020.

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.

Problem of Plenty

The surge of global liquidity added by global central banks have led to strong inflows into emerging economies like India.

So far this year, foreign portfolio flows alone have brought in a net of Rs 80,783 crore, according to data available on the National Securities Depository Ltd. One-off foreign direct investment flows have also come in this year.

In order to prevent sudden appreciation in the rupee, which in the past has led to disruptive corrections, the RBI has absorbed a large chunk of forex inflows. Since April 3, foreign exchange reserves have risen from $475.6 billion to $579 billion now.

The purchase of these forex flows in turn have added to the liquidity surplus in the domestic market, prompting analysts to question whether the RBI should permit more appreciation in the rupee.

The U.S. Treasury department’s decision to put India back on the currency manipulator’s watchlist could keep RBI somewhat “guarded on aggressive forex intervention”, said Madhavi Arora, economist at Emkay Global.

What Happens After You Label a Country a Currency Manipulator?

If the Treasury finds that manipulation is taken place, the law requires them to "take action to initiate negotiations … for the purpose of ensuring that such countries regularly and promptly adjust the rate of exchange." As a number of experts have pointed out, the United States and China already are in negotiations over China’s exchange rate, so it’s not clear what the label would actually change.

Treasury has labeled three countries as currency manipulators in the past: Japan in 1988, Taiwan in 1988 and again in 1992, and China from 1992 until 1994. According to a report by the Government Accountability Office, all three countries made "substantial reforms to their foreign exchange regimes" after the negotiations, and were removed from the list after their "currencies appreciated and external trade balances declined significantly." However, the U.S. trade deficit with China — a much larger trading partner than the other countries — has increased every year since 1988. Evidently, the labeling in the early 1990s didn’t do the trick.

Contrary to Romney’s suggestion, the law doesn’t actually give the president authority to immediately impose punitive tariffs on manipulators, and the Economic Policy Institute has suggested that such a move would violate U.S. commitments under the World Trade Organization, which require that trade spates be worked out through the organization’s the dispute settlement mechanism — potentially a years-long process.

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