Does intervention by central banks in the currency markets, with a view to keeping the home currency weak and help the exports, constitute a subsidy?

Some legislators in the United States think so. They have introduced a bill to enable levy of anti-subsidy or anti-dumping duty on such subsidised imports and to raise disputes at the World Trade Organisation (WTO).

The reasoning of the legislators goes something like this. Whenever the central banks decide to keep the home currency rates 'fixed', especially weak, with a view to helping exporters, they have to sterilise any excessive inflow of foreign currency that may otherwise cause the home currency to appreciate and thereby hurt exports.

So, they intervene in the foreign currency markets to buy up the excess supply of foreign currency. They build up foreign exchange reserves whenever they buy up foreign currency. These reserves of foreign currency are kept as deposits with the central bank of the home country of that currency. They earn very little or no interest on such deposits.

Whenever the central banks buy foreign currency in the exchange markets, they release the equivalent home currency in the home money markets. Excessive release of such home currency might lead to inflation with too much money chasing too few goods.

So, they decide to mop up the excess liquidity by floating securities at certain interest rates. In order to attract buyers they have to keep increasing the interest rates, as they resort to buying foreign currency more and more often.

The difference between the interest that the central banks give to their lenders and the interest that they earn on the deposits kept as foreign currency reserves constitute a subsidy.

Such subsidies promote exports through better home currency realisation for each unit of foreign currency. Such subsidised exports hurt the domestic producers in the importing country. Therefore, there is case for the importing country to take trade defense measures like say, anti-dumping duties or anti-subsidy countervailing duties. So goes the argument.

The immediate target of the US legislators is China , which maintains a more or less 'fixed exchange rate' of renmibi against the US dollar. The imports from China are flooding the markets, resulting in huge trade surplus for China against the US.

As a consequence, the domestic industry in the US is suffering and ultimately resulting in lower capacity utilisation and thus, fewer jobs in the US . That is why the action is justified, say the US legislators supporting the bill.

The WTO disciplines frown on the use of subsidies to promote exports. Prohibited subsidies can trigger disputes and a fast track dispute settlement mechanism can resolve the disputes quickly. It might result in sanctions against the country that gives subsidies.

But, few disputes have been fought on this issue and indirect subsidies always make it difficult to establish that a prohibited subsidy has been given or the severity of the proposed sanctions. The WTO rules for levy of anti-dumping duties permit action if the export price is lower than the 'normal value' i.e the domestic price.

The rules for anti-subsidy countervailing actions allow actions against subsidies that are a bit too apparent. So, the steps proposed by the US legislators may not be WTO compatible. They may not succeed but they have, certainly, brought the issues out in the open.