India has again found itself among the countries tagged as currency manipulators on the US Treasury Department’s list. The move appears to have reinforced the view that the Reserve Bank of India (RBI) should allow the rupee to appreciate and reduce its intervention.
Surely the two problems may not be closely related. The fact that the United States describes India as a currency manipulator is not surprising. In 2018, when we were so named in the semi-annual report on the main trading partners, the RBI had sold $ 15 billion in the national spot currency market. It had also reduced its outstanding forward position to a negative $ 2.4 billion from $ 26 billion, indicating an approximate sale of $ 23.6 billion through forward contracts.
In the first nine months of 2020, the central bank has bought a whopping $ 57 billion on the spot market alone. Its purchases through forward contracts are around $ 12.6 billion. The US Treasury Department report said that Indian central bank interventions amounted to 2.4% of the country’s gross domestic product (GDP). This was a violation of one of the thresholds that the United States monitors.
That said, being branded a currency manipulator increases caution among players in the global currency market. For the RBI, it gives more credence to the arguments that the central bank should reduce its intervention. Analysts have pointed out that allowing the rupee to appreciate helps keep imported inflation in check.
The RBI needs all the help it can get to reduce inflation as retail headline printing has been above its mandatory 2-6% target for six consecutive months. What’s more, building foreign exchange reserves comes at a fiscal cost, as it prevents the RBI from buying more rupee sovereign bonds. India’s foreign exchange reserves of $ 533 billion are currently at their all-time highs. In a Nov.25 report, analysts at the State Bank of India (SBI) said abundant rupee liquidity and domestic inflation justify the central bank loosening its grip on the foreign exchange market. “If the rupee is allowed not to appreciate by force, then it will be a problem for market players,” the note said.
Either way, the RBI has a challenging task ahead of balancing the need to accumulate currency assets and prevent liquidity from spiraling out of control.
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