In today's Finshots, we try and figure out why the US treasury department put India on the currency manipulator watchlist.

Policy

The Story

Consider the laws of demand and supply. The value of a commodity rises when there’s considerable buying pressure and it tumbles when people start selling it en masse. It’s the age-old maxim that applies to almost everything you see around you, including currencies. So when the Reserve Bank of India shows an insatiable desire to buy the Indian currency by selling the US Dollar, then you are most likely to see an appreciation in its value. And when they start selling the rupee in exchange for dollars, then the value of our currency depreciates. It’s that simple.

Now, most people baulk at the mere suggestion of willfully depreciating a currency. I mean, why do it at all? But believe it or not, there is considerable merit in engaging in such an exercise. For one, if you are looking to boost exports, then a cheap currency is a godsend in many ways. Think about it. You have two use cases.

  1. Before depreciation — Where a dollar gets you 70 rupees.
  2. After depreciation — Where a dollar gets you 75 rupees.

So if you’re in the US and trying to import stuff from India, then you can buy a lot more when the currency depreciates. It’s just math and it’s not always a bad thing to let the currency slip in value. However, if you let it slip too much, then that begets its own set of problems. Thankfully, most people don’t think we are there yet. But that doesn’t mean we are out of the woods.

A couple of days back the US treasury department put us on the currency manipulator watchlist. Meaning they think we could be deliberately devaluing our currency in a bid to gain an unfair advantage. But how can they tell if we are doing something like this. Well, the US Treasury uses three benchmarks to judge currency manipulators.

1. A bilateral trade surplus with the U.S. of more than $20 billion

Meaning, if we export more to the US and then don’t import a lot, we have to make sure that the difference doesn’t breach $20 billion. If it does, then the US might flag us for being a currency manipulator. After all, if we start dumping our products at cheap prices in the US, then it hurts local manufacturers in America and if you tally the numbers from June 2019 and June 2020, you’ll see that we’ve actually breached this threshold.

2. A current account surplus of at least 3% of GDP

When our exports far exceed our imports, it could potentially be a sign that we are using a devalued currency to dump cheap goods abroad. Thankfully, India hasn’t breached this limit yet.

3. Net purchases of foreign currency of 2% of GDP over a 12-month period

That’s to say we are buying a lot of foreign currency and selling too little. And while it’s okay to dabble in such an exercise from time to time, overdoing it can be an indication that you are deliberately plotting to devalue the rupee — at least according to the US. And on this front, we seem to have breached the limit.

Once again, I want to reiterate one thing here. They haven’t branded us as a currency manipulator. In fact, the US treasury commended the RBI for being transparent about its intervention. And so they just put us on the watchlist which also includes other countries like China, Japan, Korea, Germany, Italy, Singapore, Thailand, Taiwan and Malaysia. However, they did brand Vietnam and Switzerland as active manipulators. So, yeah, they have a problem on their hands.

Or do they?

I mean, we haven’t yet talked about what really happens after you get branded as a currency manipulator. What is the US going to do? They’re just a country like any other, right? Well, yes, but they do wield considerable influence. For starters, once you’re tagged as a manipulator, they’ll most likely work with you in a bid to correct this disparity. In the event, you don’t follow through with their suggestions, then there will be some backlash. According to reports, it’s likely that the US could limit access to government contracts and development loans to countries that violate this tacit arrangement. So yeah, it’s not a nice thing to be on this list and hopefully, we can continue looking after our interest while not breaching those other conditions.

Until next time...

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