Why are India’s currency practices under watch?

India meets two of three criteria laid out for inclusion in the monitoring list. There is a large trade surplus with the US and excessive purchase of dollars. India’s trade surplus with the US in 2017—$23 billion—was higher than the $20 billion benchmark used for assessment, and net purchase of foreign currency was 2.2% of gross domestic product (GDP), higher than the 2% cut-off. India did not meet the third criteria, which is having a current account surplus of at least 3% of GDP. India’s current account is in deficit.

What is the report about?

The US treasury department releases a semi-annual report to Congress on international economic and exchange rate policies. The report highlights the currency practices adopted by major trading partners of the US. Once a country is added to the monitoring list, it will remain on it for at least two consecutive reports.

Why did the Reserve Bank of India (RBI) intervene in the forex market in 2017?

In 2017, the rupee gained 6.3%, mainly due to good foreign direct investment and portfolio investment inflows. This led to intervention by the central bank to sterilize dollar flows. Accordingly, forex reserves rose and are currently at an all-time high of nearly $425 billion. RBI’s stated policy has been that it intervenes in the forex market to curb undue volatility. But at the same time, learning from the ‘taper tantrum’ in 2013, where the US first indicated that it would be normalizing monetary policy, it would be only fair for RBI to be mindful of the need to increase forex reserves to guard against sudden outflows, currency dealers said. This argument also holds true in the context of India’s rising external debt.

What does the report mean for India?

For the country, this could be a reputational risk, especially given the context of US President Donald Trump’s rhetoric of imposing trade barriers. Experts believe the probability of India being tagged as a currency manipulator is low. This is because even China, which is known for its exchange rate management, is still only in the monitoring list despite a massive trade surplus with the US and a large current account surplus.

What does this mean for the rupee?

While the report has no impact on the rupee, RBI may become cautious about intervening in the market, especially when there is a surge in inflows. Currently, the rupee is in depreciating mode and hence there is no need for RBI to intervene. External volatility, with a rise in US bond yields, oil prices, geopolitical concerns and a threat of trade war, has led to the dollar strengthening and the rupee weakening. Slowing inflows into local financial markets and the widening current account deficit have also contributed to the weaker rupee. So far in 2018, the rupee has weakened 2.47%.