Currency Manipulation – Indian Economy Notes
Currency manipulation is a strategy employed by governments and central banks to artificially lower the value of their currencies (reducing the cost of their exports) to achieve an unfair competitive advantage. The devaluation lowers the cost of that country's exports. The trade deficits are then artificially reduced. The UPSC Exam includes currency manipulation as an important topic in the Indian Economy Syllabus
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What is Currency Manipulation?
- The US government uses this word to describe countries that it believes are participating in unfair currency practices by purposefully weakening their currencies against the dollar.
- It means that the country in question is attempting to artificially depreciate its currency to acquire a competitive advantage over others.
- As a result of the depreciation, the cost of exports from that country is reduced. The trade deficits are then artificially minimized.
What is the currency Manipulation Watchlist?
- The Currency Manipulation Watchlist is a list of countries that the US Treasury believes are participating in "unfair currency practices" that provide them with an unfair trade advantage.
- Currency interventions or monetary policies, in which a central bank buys or sells foreign currency in return for domestic currency, usually to influence foreign exchange rates or commercial policies, are examples of these practices. Additional factors include keeping inflation under control and supporting financial stability.
- The labeling of a country as a currency manipulator does not result in immediate consequences, but it does tend to erode a country's credibility in the global financial markets.
- It's worth noting that currency manipulation isn't always obvious, and some have argued that quantitative easing is a type of currency manipulation.
- It examines the currency practices of the United States' 20 largest trading partners.
Parameters used to add to Currency Manipulation list
- A country is placed on the Monitoring List if it meets two of the three criteria outlined in the Trade Facilitation and Trade Enforcement Act of 2015. On the linked website, you may learn more about the Trade Facilitation Agreement.
- The following are the criteria used to determine if a country should be included in the list:
- Over 12 months, a significant bilateral trade surplus of at least $20 billion.
- A current account surplus of at least 2% of total GDP is required (Gross Domestic Product). On the given website, you may learn more about India's GDP.
- One-sided intervention by central bank authorities in which net foreign currency purchases of at least 2% of GDP are conducted regularly over 12 months.
- If a country is on the Currency Manipulation Watchlist, it will be excluded from US government procurement contracts, resulting in considerable damage to the country's global financial reputation.
Countries in the Currency Manipulation watchlist
Based on at least two of the required criteria stated by the US Department of Treasury, the following nations are listed in the Currency Manipulation Watchlist as of December 2020:
| Nations under Currency Manipulation Watchlist (December 2020) | ||
|---|---|---|
| Country | Goods Surplus (in billions USD) | Net Purchases (% of GDP) |
| China | 310 | -0.1 |
| Germany | 62 | N/A |
| Japan | 57 | 0 |
| India | 22 | 2.4 |
| Italy | 30 | N/A |
| Malaysia | 29 | 1.1 |
| Switzerland | 49 | 14.2 |
| South Korea | 20 | -0.6 |
| Taiwan | 25 | 1.7 |
| Thailand | 22 | 1.8 |
| Singapore | -1 | 21.3 |
| Vietnam | 58 | 5.1 |
Why has India been added to the watchlist again?
- The bilateral goods trade surplus between India and the United States recently surpassed the $20 billion mark. The trade surplus was 22 billion dollars in the first four quarters alone, up to June 2020.
- According to the central bank's intervention data, India's net foreign exchange purchases increased significantly in the second half of 2019. Following the initial outbreak of the COVID 19 pandemic, India maintained net purchases for the majority of the first half of 2020. This increased net foreign exchange purchases to 64 billion dollars, or 2.4 percent of GDP, through June 2020.
- India can now limit the RBI's foreign exchange operations to protect financial stability. Global capital flows are currently threatening to overwhelm domestic monetary policy. The outcome could be an appreciating rupee as well as excess liquidity that interferes with the RBI's interest rate policy.
Implications for India
- Now that India has been added to the list of countries to watch, the Reserve Bank of India is expected to reduce its ongoing dollar purchases. This will lead to an increase in the value of the Indian currency in the following months. The impact of higher oil costs on imports will be largely offset by a stronger rupee.
- According to a report by the US Treasury Department, India has maintained a bilateral trade surplus that has been beyond the $20 billion mark for multiple years, while its net purchases have accelerated in the second half of 2019. When the COVID-19 Pandemic broke out in the first part of 2020, net foreign exchange purchases were USD 64 billion.
- India was put on the currency watchlist for the last time in October 2018 but was removed from the list in May 2019.
Conclusion
If the US government believes a country is participating in unfair trade practices, it labels it a currency manipulator. According to the United States, the country is depreciating its currency against the dollar on purpose. To put it another way, the country is intentionally depreciating its currency to obtain an unfair edge over the United States.
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| Indian Economy Notes | Forex Related Terms |
| Indian Foreign Exchange Market | Indian Forex Reserves |
FAQs
Question. What is currency manipulation?
Currency manipulation refers to the practice of a country artificially adjusting its currency’s value, typically by buying or selling large amounts of foreign exchange to influence its exchange rate. This is often done to make a country's exports cheaper or imports more expensive, thus boosting its trade balance and economic growth.
How does currency manipulation impact the Indian economy?
Question. Currency manipulation can affect India in several ways. A weaker foreign currency (such as the US dollar) can lead to a rise in the cost of imports, including essential goods like oil, which can negatively impact India’s current account deficit. Additionally, currency fluctuations can affect inflation and market stability, making it challenging for businesses and consumers to plan. Conversely, a manipulated weaker currency can make Indian exports cheaper and more competitive in the global market, potentially benefiting the export sector.
Question. Which countries have been accused of currency manipulation?
Several countries, including China, have been frequently accused of currency manipulation. For instance, China has been accused of deliberately undervaluing its currency, the Yuan, to boost its exports and create trade imbalances with other countries, including the United States and India.
Question. What measures can India take to counter currency manipulation?
India can counter currency manipulation through a variety of means, such as adjusting its foreign exchange reserves, participating in global discussions and agreements to prevent unfair currency practices, and strengthening its own currency by increasing interest rates or by market intervention. India can also seek to negotiate with other nations, particularly through international bodies like the International Monetary Fund (IMF) and World Trade Organization (WTO).
Question. What role do international organizations play in controlling currency manipulation?
International organizations such as the International Monetary Fund (IMF) and the World Trade Organization (WTO) work to promote fair trade practices, including addressing currency manipulation. The IMF monitors exchange rates and can take action against countries that engage in manipulative practices that harm the global economy. The WTO, on the other hand, can mediate disputes between countries over currency-related issues.
MCQs
- What is the primary aim of currency manipulation?
A) To reduce foreign exchange reserves
B) To make exports cheaper and imports expensive
C) To stabilize domestic currency
D) To encourage foreign investments
Answer: (B) See the Explanation
Currency manipulation is primarily used to devalue a country’s currency, making its exports cheaper in foreign markets and its imports more expensive, thereby improving its trade balance.
- Which of the following countries has been most frequently accused of currency manipulation?
A) United States
B) India
C) China
D) Japan
Answer: (C) See the Explanation
China has been frequently accused of manipulating its currency, the Yuan, to maintain a trade surplus by keeping its currency undervalued, thus making its exports cheaper.
- How can currency manipulation affect India’s economy?
A) It can increase India’s foreign exchange reserves
B) It can reduce India’s inflation rate
C) It can negatively affect India’s import costs, especially for oil
D) It can improve India’s agricultural exports
Answer: (C) See the Explanation
Currency manipulation can lead to an increase in the cost of imports for India, particularly for essential goods like crude oil, which can affect inflation and the current account deficit.
- Which international organization monitors currency manipulation?
A) World Trade Organization (WTO)
B) United Nations (UN)
C) International Monetary Fund (IMF)
D) World Bank
Answer: (C) See the Explanation
The IMF monitors the foreign exchange policies of member countries and can take action against those engaging in currency manipulation to ensure the stability of the global economy.
- What is one potential benefit of currency manipulation for a country?
A) Increased foreign debt
B) Boost in export competitiveness
C) Increased import costs
D) Strengthened currency reserves
Answer: (B) See the Explanation
By devaluing its currency, a country can make its exports cheaper in international markets, which boosts export competitiveness and helps improve its trade balance.
GS Mains Questions and Model Answers
Q1: Discuss the implications of currency manipulation on the global economy and India’s economic stability.
Answer: Currency manipulation, which involves artificially adjusting the value of a country’s currency, has far-reaching consequences for both global and national economies. For India, the impact can be both positive and negative. On the one hand, currency manipulation by other countries, particularly by undervaluing their currencies, can make their exports cheaper and increase trade imbalances. This can lead to unfair competition for Indian businesses, especially in the export sector. India may face challenges in maintaining a balanced trade account, leading to a growing current account deficit. On the other hand, India itself could resort to currency manipulation as a strategy to boost its own exports. A weaker rupee makes Indian goods more attractive in foreign markets, potentially improving India’s export competitiveness and economic growth. However, the negative impacts, such as higher import costs (particularly for oil), inflation, and financial instability, could offset these gains. Globally, currency manipulation undermines fair trade and disrupts international markets. It can cause tensions between nations, particularly if countries accuse others of deliberately devaluing their currencies for competitive advantage. The role of international bodies like the IMF and WTO becomes crucial in ensuring that currency policies remain fair and equitable for all nations involved. In conclusion, while currency manipulation might offer short-term economic benefits, its long-term effects can destabilize both the national economy and the global financial system.
Q2: How does currency manipulation affect India’s trade balance and inflation rates?
Answer: Currency manipulation can have significant effects on India’s trade balance and inflation rates. When another country manipulates its currency to make its exports cheaper, it often leads to an increase in India’s import costs. This is particularly true for essential commodities like crude oil, which India imports in large quantities. A rise in import costs, especially oil, can lead to inflationary pressures in the Indian economy, increasing the prices of goods and services across sectors. Additionally, currency manipulation can distort India’s trade balance. A devalued currency in another country makes its products cheaper for Indian consumers, thereby increasing imports. Simultaneously, Indian exports become less competitive if the domestic currency strengthens or remains stable, as compared to the manipulated currency. As a result, India could see a widening trade deficit. In response, India might resort to currency interventions, such as buying or selling foreign currency, to stabilize the value of the rupee and maintain trade balance and inflation levels. However, such interventions can only offer temporary relief and often come with long-term economic consequences.
Q3: Evaluate the role of international financial institutions like the IMF and WTO in controlling currency manipulation.
Answer: International financial institutions like the International Monetary Fund (IMF) and the World Trade Organization (WTO) play a crucial role in monitoring and controlling currency manipulation to ensure fair trade and economic stability. The IMF is responsible for monitoring exchange rate policies and providing financial support to countries facing economic imbalances. It encourages countries to adopt transparent and market-determined exchange rate policies and advises on measures to prevent currency manipulation. In cases where a country is suspected of manipulating its currency, the IMF can intervene by offering technical assistance, conducting consultations, and recommending policy adjustments. The WTO, on the other hand, focuses on promoting fair trade practices. While its main role is not directly related to currency manipulation, it can mediate disputes between countries over trade imbalances caused by currency policies. The WTO ensures that trade rules are not distorted by unfair practices like currency devaluation, which can lead to trade wars and economic instability. In both cases, these international bodies act as a check on practices that could disrupt global markets, ensuring that countries engage in fair and balanced trade practices. Their role is essential in maintaining the stability of the global economy and preventing the harmful effects of currency manipulation.
Previous Year Questions on Currency Manipulation
1. UPSC CSE 2023
Question: Examine the impact of currency manipulation by trading partners on India’s trade and economy.
Answer: Currency manipulation by trading partners can have a profound impact on India’s trade and economy. When countries devalue their currencies to boost exports, they create an uneven playing field. For India, this means its exports may become less competitive in the global market, leading to a loss of market share. At the same time, a devalued currency in a trading partner country can increase the cost of India’s imports, especially for critical items like crude oil. This leads to a higher current account deficit and inflationary pressures. The Indian government may have to intervene in currency markets to stabilize the rupee, but such actions can come with long-term economic costs. Currency manipulation, thus, disrupts the balance of trade and impacts inflation and growth rates in India.
2. UPSC CSE 2022
Question: Discuss the measures that India can take to protect its economy from the adverse effects of currency manipulation.
Answer: India can adopt several measures to protect its economy from the adverse effects of currency manipulation by other countries. Firstly, it can enhance its foreign exchange reserves to shield the rupee from volatility. India can also actively participate in international forums like the IMF and WTO to push for stronger regulations against unfair currency practices. Another option is to adjust domestic policies, such as increasing interest rates to attract foreign investments and strengthen the rupee. Additionally, India can diversify its export markets to reduce dependence on countries that engage in currency manipulation. Finally, strengthening its trade relations with countries that follow fair currency practices could mitigate the negative impact of manipulation on India’s trade balance and economy.
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