India on currency manipulation watchlist: Is that a cause for concern?

The US Treasury has, while branding Switzerland and Vietnam as currency manipulators, added India, Taiwan and Thailand to its “Monitoring List”, which also includes China, Japan, Korea, Germany, Italy, Singapore and Malaysia. The review period for the list was for the four quarters to June 2020. 
 

On what basis is a country branded a currency manipulator?
 

The US follows three criteria: A country has to persistently intervene in its currency market with an aim to keep the currency relatively weaker; the country should be running significant trade surplus vis-a-vis the US; and the country has to have a current account surplus.
 

A monitoring list, however, takes into account any two of the three factors.
 

Why has India been put on the list?
 

India has been included because of “having a material current account surplus and engaging in persistent, one-sided intervention over the reporting period”. India’s trade surplus with the US has been $22 billion for many years, but that is not enough for the US to red-flag it. India’s net purchase of foreign exchange, however, was aggressive at $64 billion, or 2.4 per cent of the GDP, for the review period. The foreign exchange accumulation was made possible by persistent intervention by the RBI. 
 

What happens when a country is put on the list?
 

Once on the list, an economy remains 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”.
 

Is that a cause for concern for India? 
 

Not really. It is a technical classification and does not affect the relationship with the US materially. In fact, India was on the list in April 2018, but was out by May 2019. The US Treasury rather praised India for being transparent in how it handles its intervention and foreign exchange policies. The Treasury, though, advised India to let rupee find its own value against the US dollar based on economic fundamentals. 
 

How can India get out of the list? 
 

India by itself may not need to put any extra effort for that. The current account surplus was caused by demand contraction due to the Covid pandemic. Even as India imported less, easy money-fed portfolio flows chased Indian yields. The result was a current account surplus, which should go away once demand returns. Already, inflation is showing signs of becoming sticky. And the current account surplus may turn into a deficit in the first half of the next year itself. If the deficit prevails for one more year, India will automatically be out of the list. 
 

So will the RBI let the rupee appreciate?
 

Not really. The rupee, in fact, depreciated after the inclusion of India on the list. There is unlikely to be any change in RBI’s currency intervention policy. A strong rupee does not help in economic recovery, which is the primary focus of the RBI and the government. A relatively weaker rupee, on the other hand, helps gain the export share. So, the RBI will be in no hurry to let rupee appreciate because India figures on the watchlist. Rather, waiting for the current account surplus to turn into an automatic deficit is a far more convenient way out of the list. The rupee eventually will appreciate for organic reasons. There is a limit to how much the RBI can maintain foreign exchange reserves. At $580 billion, it is already about $30 billion in excess than the country’s capacity, say economists. The accumulated dollars will have to be invested in foreign assets, yields on which are less than 2 per cent. So, RBI will have to slow down or stop building up its reserves. Once it does so, the rupee will appreciate.