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Indian Rupee Dented as U.S. Treasury Fingers Indian Authorities for Potential Currency Manipulation

- INR takes leg down after US adds India to monitoring list.

- Could result in less currency intervention in months ahead.

- Lesser degree of currency intervention will be Rupee-positive.

© Goroden Kkoff, Adobe Stock

The Indian Rupee fell broadly against the developed world currency basket during the morning session in London Monday as markets responded to the latest currency report from the US Treasury, which saw India placed on the Treasury's monitoring list. 

Earning a place on the monitoring list of the US Treasury could ultimately see India designated by the US as a "currency manipulator", although the risk of this happening is still seen as being quite low, with any eventual determination also remaining a long way off. 

Nonetheless, and presumably because of the recent increase in trade-related "protectionism" from the US government, markets have taken the development seriously by sending the Rupee lower on Monday.

The USD/INR rate was up 0.7% to 93.60 during the morning session Monday while the Pound-to-Rupee rate was 0.3% higher at 65.44. Both exchange rates have risen notably in 2018.

Above: USD/INR rate shown at daily intervals.

Above: Pound-to-Rupee rate shown at daily intervals.

"India’s addition is significant in our view and will have important implications for the country’s FX practices going forward," says Cristian Maggio, head of emerging market strategy at TD Securities. "Going forward we think it will be difficult for intervene to buy FX without running the risk of facing US criticism. Indeed, the Treasury Reported that India’s FX reserves are “ample” and that “further reserve accumulation does not appear necessary”.

The US Treasury criteria for labelling a country as a currency manipulator are simple in that the country in question must tick three boxes. It should have a trade surplus of more than $20 billion with the US, a current account surplus of more than 2% of GDP and have carried out foreign currency purchases equivalent to 2% of GDP over a 12 month period. India meets two of these three conditions, hence its addition to the US Treasury monitoring list, but has a large current account deficit.

Being labelled a manipulator has no automatic consequences in US or international law although it is seen as something that is likely to warn designated countries away from intervention in the currency markets. Currency intervention typically sees a central bank dumping its own currency on the market in exchange for foreign currencies, which has the effect of forcing exchange rates lower. This provides the domestic economy with a competitive advantage in international trade.

"The current account is perennially in deficit, and it widened a touch to 1.5% of GDP in 2017," says Shilan Shah, an India economist at Capital Economics. "There is nothing stopping the US Treasury from changing its criteria, but the size of the current account deficit will probably be enough to prevent India from being labelled a “currency manipulator” for now."

That said, India's inclusion on the US Treasury's list is seen by those at TD Securities as something that will encourage the Reserve Bank of India to refrain from further intervention in the currency market, which should leave the Indian Rupee free to appreciate over the coming months. The currency has fallen around 7% against the Pound in 2018 and by 2.6% against an already-weak US Dollar.

There are other factors that could aid the Indian Rupee higher over the course of 2018 too, with the most notable being high levels of inflation and the prospect of an RBI interest rate rise before year-end. Headline Indian inflation slipped lower, to 4.3%, in March but core consumer prices actually picked back up.

The core consumer price index removes volatile food and energy goods from the price basket and so is seen as providing a more accurate representation of domestically generated inflation pressures. And while Indian food and energy prices have slipped in recent times, wage growth and rising levels of industrial production are seen pushing up on the core measure of infaltion during the months ahead. This could prompt the Reserve Bank of India to respond with an interest rate rise.  

"Despite the easing in headline CPI inflation over the past couple of months, we remain comfortable with our view that the RBI will hike rates later this year as core price pressures build. The consensus has shifted to expectations of policy tightening, but not until mid-2019," says Shah.

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