From UPSC perspective, the following things are important :
Prelims level : Various monetary policy tools
Mains level : Currency manipulation
The U.S. Treasury has labelled Switzerland and Vietnam as currency manipulators and added three new names, including India, to a watch list of countries. Earlier it had removed India from the list in March 2019.
What is Currency Manipulation?
- Currency manipulation refers to actions taken by governments to change the value of their currencies relative to other currencies in order to bring about some desirable objective.
- The typical claim – often doubtful – is that countries manipulate their currencies in order to make their exports effectively cheaper on the world market and in turn make imports more expensive.
Why do countries manipulate their currencies?
- In general, countries prefer their currency to be weak because it makes them more competitive on the international trade front.
- A lower currency makes a country’s exports more attractive because they are cheaper on the international market.
- For example, a weak Rupee makes Indian exports less expensive for offshore buyers.
- Secondly, by boosting exports, a country can use a lower currency to shrink its trade deficit.
- Finally, a weaker currency alleviates pressure on a country’s sovereign debt obligations.
- After issuing offshore debt, a country will make payments, and as these payments are denominated in the offshore currency, a weak local currency effectively decreases these debt payments.
US treasury’s criteria
To be labelled a manipulator by the U.S. Treasury:
- Countries must at least have a $20 billion-plus bilateral trade surplus with the US
- foreign currency intervention exceeding 2% of GDP and a global current account surplus exceeding 2% of GDP
Implications for India
- India has traditionally tried to balance between preventing excess currency appreciation on the one hand and protecting domestic financial stability on the other.
- India being on the watch list could restrict the RBI in the foreign exchange operations it needs to pursue to protect financial stability.
- This comes when global capital flows threaten to overwhelm domestic monetary policy.
- The two most obvious consequences could be an appreciating rupee as well as excess liquidity that messes with the interest rate policy of the RBI.
- Indian policymakers have to be sensitive for the unpredictable nature of policy-making in the US under Trump, especially concerning global trade.