Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

Opinion | The complexity of tracking currencies

With rising trade tensions, currency is likely to remain in focus—but the US’ approach to monitoring the movement of currencies is too simplistic

The US treasury department is likely to remove India from its currency monitoring list. India should not have been on the list in the first place. The rupee has weakened in excess of over 15% against the dollar since the beginning of the year because of the rising current account deficit and tightening financial conditions in global markets. India’s foreign exchange reserve declined by over $5 billion in the week ended 12 October and is likely to have been used to contain volatility in the currency market. This indicates the level of difficulty involved in managing the external account of an emerging market country such as India. However, given the current global economic conditions, currency movement is likely to remain in focus—both in India and around the world.

The US has a very mechanical way of analyzing whether its trading partners are using currency to push exports. It puts large trading partners on the watch list if they meet two of three criteria. First, the bilateral trade surplus with the US should be in excess of $20 billion. Second, the trading partner should be running a current account surplus of over 3% of gross domestic product (GDP). And third, there should be continued one-sided intervention in the currency market with net purchase worth at least 2% of GDP over the period of one year. India was included in the list as it runs a trade surplus with the US which is higher than $20 billion, and the Reserve Bank of India (RBI) was aggressively buying foreign exchange in 2017 to build reserves. However, India was running a current account deficit, which showed that it was a net buyer from the rest of the world. The US treasury department notes in its report: “India has been exemplary in publishing its foreign exchange market intervention." This is not new and interventions should be seen in the larger context of the overall economic situation.

In fact, contrary to the possibility of manipulating currency, a country like India has to deal with spillovers of policy changes in advanced economies, forcing policymakers to intervene in the market. Non-intervention can significantly increase volatility and financial stability risks. For instance, India suffered a great deal during the taper tantrum episode of 2013, partly because intervention in the preceding period was less than required. Subsequently, it needed to build reserves to avoid a similar situation. Indeed, it could be argued that the Indian central bank should have accumulated reserves more aggressively over the last few years. It would have not only helped in avoiding a large real rupee appreciation but also increased RBI’s firepower in containing volatility at a time of reversal of capital flows.

Nonetheless, with rising trade tensions, currency is likely to remain in focus and the US will keep monitoring the movement of currencies like the Chinese renminbi. China runs a large trade surplus with the US and US president Donald Trump is determined to reduce it dramatically. China has a history of strong interventions in the currency market. As the report highlights, China’s current account surplus went up from about 2% to 10% of GDP between 2001 and 2007. Further, from 2002 to 2009, net buying in the foreign exchange market averaged about 9% of GDP.

But things have changed in recent years. The Chinese economy is slowing. The government is rebalancing the economy and China lost about $1 trillion worth of reserves in defending its currency in recent years. Yet, the US is not comfortable with the recent decline in renminbi, which is negating the impact of higher tariffs to a large extent. The US is also not pleased with the fact that China still refrains from disclosing foreign exchange interventions. Therefore, it is likely that currency movement can escalate trade tensions further. The renminbi might weaken further, partly because higher tariffs will affect economic activity in China. It is also likely that the dollar will continue to strengthen on the back of higher interests rates and put pressure on other currencies. Higher budget deficit and a strong dollar are unlikely to help Trump reduce the US’s current account deficit.

Aside from the risk to the global economy from protectionism and targeting currency movement, the persistence of trade imbalances needs attention. Germany, for instance, runs a current account surplus of over 8% of GDP. Such imbalances in global trade can be a risk as has been witnessed in the eurozone itself. However, trade imbalances may not be corrected by targeted tariffs. It needs broader coordination and policy correction in both the countries that are saving and consuming excessively. But with the US turning inward, that possibility is receding.

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