Japan’s yen lesson for India: Don’t fight the currency market

New York: Here's a simple lesson for India from the massive, yet unsuccessful, joint Japan-US intervention to prop up the yen: don't squander India's precious forex reserves trying to manage the rupee's exchange rate. Don't become fixated on a particular exchange rate as a symbol of national pride.

Exchange-rate jingoism can be expensive and wasteful. Instead, focus on macroeconomic fundamentals and keeping the economy in sound shape. The exchange rate is ultimately a price, best left largely to the market.

Since January, Japan has purchased more than $100 bn worth of yen - by some estimates, as much as $150 bn - to prop up its sliding currency against the dollar. Market participants believe that the government intervenes when the yen approaches the threshold of 160 to the dollar. The first major intervention this year came in April and May, when Japan's finance ministry purchased $73 bn worth of yen. But the intervention provided only a temporary reprieve.


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In July, the yen fell to 163 to the dollar, triggering a joint intervention by the US treasury and Japan's finance ministry. The US government reportedly dipped into its euro reserves to purchase yen. This, together with the Bank of Japan's (BoJ) purchases, pushed the yen up to 155 to the dollar. Yet, less than two weeks later, almost half of the yen's gains from the intervention had evaporated.

Trump boasted that the US was helping a friend in need. The US' ulterior motive, however, appears to have been limiting Tokyo's sale of US treasury securities, of which BoJ is one of the largest holders. Large-scale sales of treasuries could push bond yields higher. Indeed, despite these interventions, a $25 bn US treasury auction of 30-yr bonds last week came at a yield of 5.2%, the highest in a quarter century. The last time yields were this high, in August 2001, the treasury subsequently suspended 30-yr bond auctions for 5 yrs.

Japan's finance ministry has said it will continue to intervene to stabilise the yen. With a massive stock of roughly $1.3 tn in foreign assets and currencies, Japan has the capacity to continue intervening for several more months. Because many of these reserves were accumulated when the yen was stronger, Tokyo can even realise a gain when it sells some of these foreign assets to buy yen.

But if the primary objective is to prevent the yen from falling, currency intervention is, at best, a short-term band-aid. The underlying problems lie elsewhere. Japan has one of the highest debt-to-GDP ratios among advanced economies, exceeding 200%. This ratio could rise further under Prime Minister Sanae Takaichi's fiscal stimulus programme, which includes a growth strategy centred on massive public investment as well as measures to provide household subsidies to offset rising energy bills.

The US-Japan effort to manage the yen-dollar exchange rate is only one of several instances in which powerful central banks, despite having enormous financial resources, have ultimately lost their battle against private financial markets in defending overvalued currencies. Perhaps the most famous example is George Soros' challenge to Bank of England (BoE) in 1992.

Under the European Exchange Rate Mechanism (ERM), the British pound had to remain within specified bands relative to the German mark. The market believed the pound was substantially overvalued. Yet, BoE continued buying pounds to keep the currency within ERM bands.

It all came to nought on September 16, 1992 - 'Black Wednesday' - when Soros took a roughly $10 bn position against the pound. Pressure ultimately forced the British government to devalue the currency and withdraw from the ERM. Soros reportedly made about $2 bn on the trade, earning him the reputation of the 'man who broke the Bank of England'.

It's better to learn from the mistakes of others than by repeating them. Depreciation of the rupee over the past few months has caused considerable pressure on GoI to 'act' and not let the rupee fall below 100 to the dollar. Yet, mightier central banks provide a simple lesson: do not waste time or resources fighting the market.

RBI is in a good position to manage the rupee in the face of a global financial crisis because, although the rupee is convertible on the current account, India doesn't have full capital account convertibility. This gives GoI and RBI greater scope to restrict large-scale capital outflows in the event of a crisis. Full capital account convertibility, by contrast, would substantially limit the authorities' ability to impose such controls.

The writer is professor of social policy, Columbia University, US