India’s Efforts to Curb the Rupee Are Getting Harder

Updated on
  • Treasury report includes rare criticism of India FX policy
  • Analysts say RBI may need to go slow on intervention

Urjit Patel, governor of the Reserve Bank of India, has been seeking to curb rupee appreciation.

Dhiraj Singh/Bloomberg

India’s currency management just got harder.

The U.S. Treasury said last week it will "closely monitor" the Reserve Bank of India’s policies after a "notable increase in the scale and persistence" of dollar purchases. While it refrained from adding India to its watch list for potential currency manipulators, it noted that foreign-exchange buying had risen to 1.8 percent of gross domestic product in the year through June, just below the Treasury’s 2 percent red line.

The glare of this spotlight may hamper Governor Urjit Patel’s freedom to curb sharp gains in the rupee. Losing the ability to intervene could prove costly though: an overvalued currency has been cited as keeping exports expensive, hurting competitiveness at a time when global demand is recovering.

“India obviously could change its intervention policy a bit to draw a bit less attention -- the RBI has been intervening, by all appearances, at around 64 rupees to the dollar and looked to be trying to set a de facto ceiling on the level of the rupee,” said Brad Setser, senior fellow at the U.S.-based Council on Foreign Relations who worked at the Treasury from 2011 to 2015. “Its actions in the market haven’t been particularly subtle.”

The RBI says it doesn’t target any level and only intervenes to smooth volatility. It didn’t reply to an email seeking comment on the Treasury report. Inclusion on the watch list carries the risk of sanctions.

The rupee has strengthened 4.3 percent this year, heading for its first annual gain since 2010, and was trading at 65.1625 per dollar as of 10:33 a.m. in Mumbai on Wednesday. An index of the currency’s real-effective exchange rate was at 116.83 in September, near the record seen in April, indicating it is overvalued against a basket of 36 trading partners.

‘Edging Closer’

India’s foreign-currency purchases have largely been driven by the need to bolster reserves since the 2013 taper tantrum, which pushed the rupee to a record low. Since then, holdings have swelled to over $400 billion as the RBI mopped up large inflows into the nation’s stocks and bonds.

“With the potential for India to experience further portfolio and direct investment inflows, we believe there could still be space for the rupee to appreciate if the RBI steps back from its aggressive dollar-buying,” analysts at Nomura Holdings Inc. wrote in an Oct. 18 report. “India seems to be edging closer to being included on the monitoring list, unless it starts to manage the pace of its dollar buying intervention.”

To avoid the Treasury’s ire, the RBI’s intervention -- including in the forwards market -- needs to be less than $4 billion a month, according to Khoon Goh, Singapore-based head of Asia research at Australia & New Zealand Banking Group. It has been breaching that level since May, he said.

Risk of Sanctions

The Treasury report comes at a time when President Donald Trump’s administration is pushing for warmer relations with India to counter China’s growing might in Asia. Secretary of State Rex Tillerson is visiting India this week, after outlining the administration’s vision for India in a key policy speech on Oct. 18.

Placement on the Treasury’s watch list can trigger sanctions if the country satisfies three criteria: persistently intervening in currency markets, running a significant trade surplus with the U.S. and running a large current account surplus overall. The five countries on the watch list -- China, Japan, South Korea, Germany and Switzerland -- fulfill some but not all of the conditions required to be named as a currency manipulator.

India runs a $25 billion trade surplus with the U.S., its largest with any country in 2016. This is also America’s 10th-largest bilateral deficit, data compiled by Bloomberg show, though it’s far smaller than China’s $327 billion, Germany’s $66 billion and Japan’s $63 billion. Moreover, India has a ballooning current-account shortfall that contrasts with nations such as Thailand.

“If the U.S. is really going to go after some countries on currency, they should be looking at countries with large external surpluses like Thailand, Taiwan and Korea – not at India,” said CFR’s Setser.

— With assistance by Karthikeyan Sundaram

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