India on US watch list over trade surplus: should Delhi worry?

Over the four quarters ending June 2017, India ran a trade surplus of $23 billion against the United States, which has prompted the US Treasury “to closely monitor India’s foreign exchange and macroeconomic policies”, according to a recent Treasury publication.

The publication also said that while India’s foreign exchange reserves were 16% of its GDP — lower than many of America’s other trading partners — the forex reserves as a percentage of short-term external debt (that is debt of less than one year maturity) are at 412%, which is the second-highest (Brazil tops at 702% while for China it is 360%) among all major trading partners of the US.

Building up official foreign exchange reserves by selling Indian rupees against US dollars implies an artificial depreciation of the rupee. Though the magnitude of India’s intervention in the currency market is nothing compared to the scale at which China had traditionally managed its currency, it is significant that the Trump administration has started putting India under the lens. At the end of June, when the Treasury study was conducted, India’s reserves stood at around $362 billion. Since then, the RBI has further stepped up its reserves accumulation and India’s reserves now stand at $400.3 billion.

Several questions crop up. One, does India need this level of reserves, which provides a cover of 13 months’ imports, where several analysts consider seven months’ import cover to be adequate. Of course, there is no rule to determine the need for reserves. It depends on the source, and hence the durability, of the funds. Though for China, most of its reserves are ‘earned’ through exports, it is different for India, which largely depends on the inflow of ‘borrowed’ and ‘fickle’ FII and NRI money.

An alternative rule of thumb is to have reserves at least equal to the current account deficit, which is around $80 billion. So, on that count, too, we have some $320 billion of excess reserves, a large part of which are held in foreign banks and US government securities and earn very low interest. Consequently, a suggestion mooted by some analysts to transfer a part of the excess reserves (say, $100 billion) to an India Infrastructure Investment Fund merits serious attention. This fund can be left to the management of a board of reputed experts to boost investment in India, especially at a time when private investment is not picking up, which is the major cause for the economic slowdown.

Second, should the US be so concerned about India’s trade surplus and foreign exchange build-up? In 2016, the total US trade deficit was $750 billion. Out of that, the deficit in goods was $347 billion with China alone (46% of total US deficit), $69 billion with Japan (9.2%), $65 billion with Germany (8.6%), $63 billion with Mexico (8.4%), $11 billion with Canada (1.5%), $23 billion with India (3.1%). As for reserves, compared to Switzerland (109%), Taiwan (81%), China (27%), Korea (25%) and Japan (24%), India’s reserves amount to only 16% of GDP. So, on either count, India should not be an immediate priority on the watch list.

At the same time, we should note that the US deficit in goods with India has been steadily rising over the years (it was only $4.7 billion in 2007) and the deficit in goods and services amounts to a much higher figure of $30.8 billion in 2016, which was 6.1% of the total US multilateral trade deficit in goods and services that year.

This brings us to a more fundamental question. Why has US been running a huge persistent multilateral trade deficit for many years, irrespective of whether the Democrats or the Republicans ruled or whether the US was running a budget deficit or surplus (as during Bill Clinton’s presidency)? Is it due to faulty US policy or the machinations of some countries like Japan, China and Germany (now joined by India)?

Biggest borrower
All industrially advanced countries, including the EU, run a trade surplus. The US, the richest country in the world, in contrast, is the biggest borrower in the world, importing capital from abroad to finance its burgeoning trade deficit. Analysts point to two major factors here.

One, the US dollar is the world’s primary reserve currency and also the currency in which most international transactions are carried out. These lead to an artificial demand and high value for the US dollar, causing a loss of international competitiveness for US goods and thus, a trade deficit. The so-called currency manipulation by other countries is, at best, a sideshow.

Two, the US maintains an artificially high standard of living with borrowed money from abroad. The overall trade deficit will persist so long as the US spends beyond its means. If it buys less from a country like China, it would end up buying more from another, unless it cuts down on overspending. Politically, it may be convenient to blame some other countries, but the primary fault lies with US policy.

Worse, Donald Trump, with his tax cuts, is set to aggravate the problem as it will further reduce US savings. Even if the US trade deficit is sustainable in financial terms
(to the extent the rest of the world is willing to lend to the US), it is not politically sustainable as it leads to loss of jobs in a concentrated manner in some regions, leading to rust belts and a political backlash.

Consequently, to be politically correct, some countries would have to be placed on the watch list. But, as explained above, for the time being, India should be more concerned with the H-1B visa issue than with rising trade surplus and reserves.

(The author is a former Professor of Economics, IIM, Calcutta)