It is surprising to hear from the US Treasury that the strengthening Indian economic metrics, currently facing a three year low quarterly growth, could hurt it. For a country that is still not out of the twin-deficit (fiscal and current account) problem, it would appear to be an odd assessment, but that’s what Uncle Sam says.
In an October 17 report to the US Congress, the Treasury said it would closely monitor India’s foreign exchange and macroeconomic policies because “over the first half of 2017, there has been a notable increase in the scale and persistence of India’s net foreign exchange purchases, which have risen to around $42 billion (1.8% of GDP) over the four quarters through June 2017.”
Yes, the acceleration of India’s foreign exchange reserves has given a sense of satisfaction for many who were tired of frequent sell-off of the currency and the Reserve Bank of India’s inability to protect the slide in its value. But have things changed so dramatically that India needs to be put on par with either China, with more than $3 trillion in reserves, or Germany, which remains the workshop of Europe with enormous amount of trade surplus which is one of the key reasons for friction among the European Union nations.
“By most economists’ estimates, the rupee is at best fairly valued if not a little overvalued,” says Brijen Puri, head of markets for India, JPMorgan. “Moreover, the current account (deficit) is forecast to widen and the portfolio inflows reduce – materially narrowing the balance of payments surplus. This would result in a much slower pace of reserve accumulation in the coming months.”
India has added $30.5 billion in foreign exchange reserves to $398.7 billion over the past one year with consistent foreign investment flows. During the period, the rupee has gained 3.4%, or Rs 2.31, versus the US dollar, and this year it is up 3.8%.
WHY MONITOR INDIA?
While the watch on India is no equivalent to that of the attention US pays to China for contributing to global imbalances and its enormous trade deficit with the Middle Kingdom with its consecutive devaluations of the Yuan over the years, the glare could slow Reserve Bank of India’s foreign currency purchases confounding policy choices.
The US motive is to protect American workers and companies from unfair outside competition and to prevent its major trading partners from deliberately keeping currency undervalued to gain competitive advantage in exports.
The US Treasury looks at three major factors to assess its trading partners’ foreign exchange policies to dub a country as ‘currency manipulator’. If a country has over $20 billion in bilateral trade surplus with the US; a country runs a minimum 3% current account surplus of the gross domestic product; and persistent one-sided intervention with net foreign currency purchases crossing 2% of GDP over 12 months.
India met only one of these criteria with its bilateral goods surplus with the US at $23 billion for the four quarters to June 2017, but treasury heads managing foreign currencies are a little concerned as to what would be the fallout of the US Treasury observation.
“RBI may have a tough choice in its hands — whether to allow market forces appreciate the rupee or intervene aggressively to keep rupee under check,” says Anindya Banerjee, a currency analyst with Kotak securities. “If it opts for the former, the rupee may become global currency speculators’ preferred choice to play the carry game. However, if it opts for the latter, it can risk flagging the criteria on accumulating reserves (more than 2% of GDP) over a 12-month period.”
STILL WEAK, THOUGH NOT FRAGILE
Unlike Germany or China, India is not a net exporter of manufactured items or services leading to a high current account surplus. On the contrary, India’s macro economy is still weak as it runs a current account deficit – importing more than what it exports.
This puts the country in a vulnerable position in terms of global financial volatility as it happened in 2013 when the US Federal Reserve chairman gave the first hint of rolling back the record monetary easing programme.
India’s current account deficit (CAD) has widened to $14.3 billion, or 2.4% of GDP, in the June quarter and it may worsen further given the rise in global crude oil prices. The deficit is funded by capital flows in the form of foreign direct investment and foreign portfolio investments.
There is always a risk of capital flows reversing quickly during adverse global events, which needs an emerging economy like India to have enough reserves to match the demand.
“India needs to build reserves in order to protect against outflows,” former Reserve Bank of India Governor Raghuram Rajan, now a professor at University of Chicago Booth School of Business, was quoted as saying recently. “We can’t keep running to the IMF for help as a large country, and politically, it’s very difficult... So, reserves should be seen as a macro prudential tool.”
IMF’S WORRIES
None of the major trading partners of the US met the standards identified as currency manipulator, but the US Department of the Treasury Office of International Affairs created a monitoring list and put China, Japan, Korea, Germany and Switzerland under close vigil. The Treasury is especially pushing China, which had a $357-billion bilateral trade surplus with the US at the end of June “to expand market access for US goods and services and address industrial policies that unfairly discriminate against US firms.”
The Trump administration is “deeply concerned over the significant imbalances in the global economy”. The IMF 2017 External Sector Report said that 11 advanced economies had current account surpluses in 2016, and one-third of them have excessive surpluses creating global imbalances in trade and consumption.
The IMF identified that real effective exchange rates in these countries with surpluses were generally undervalued. On a 20-year rolling average basis, the yen is more than 20% and euro 4% below their long-term real effective rates.
While export-dominated economies such as China and Japan have often used currency as a tool to retain competitive advantage in global trade, India uses it more to temper the volatility in the currency markets and to keep its monetary policy effective.
“India has been traditionally a current account deficit economy... So, India is in no way contributing to global imbalances,” says Partha Ray, an economics professor at the Indian Institute of Management at Kolkata. “The RBI’s policies are torn by tensions of the impossible trinity (managing interest rate, inflation and exchange rate).
Hypothetically speaking, even if the RBI intervenes heavily, given the semi-open structure of India’s capital account, the RBI will not be able to influence the exchange rate beyond a point.’’
With many battles to fight for the economic upliftment of millions of poor in an open economy, the attention from the US Treasury may just be a vaunted status for India, at least for now.
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