Lokeshwarri SK

Watch out for currency manipulators

Lokeshwarri S K | Updated on July 10, 2012

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Restrictions on futures trade can curtail the manipulator’s reach, suggests Dr Kaushik Basu.

Ask the question, what makes the rupee volatile and you get a barrage of answers ranging from India’s bloating current account deficit to dwindling foreign portfolio flows. But the role of currency manipulators rarely finds a mention.

That is a trifle strange because it is no secret that the global foreign exchange market that trades around $4 trillion everyday has a wide swathe of participants. While there are those who buy and sell currency to hedge their foreign exchange exposure, there are many, including hedge funds, who bet on the currency volatility to make money. The latter group is suspected of causing exaggerated currency movements. 

Regulators could duck behind the argument that the size of the foreign exchange market acts as a barrier to price manipulation. The combined volume on the inter-bank and exchange-traded currency markets in India is, for instance, higher than that on equity markets. Is it possible for a single player to influence price movement in currencies? Dr Kaushik Basu in his paper, The Art Of Currency Manipulation: How Some Profiteer By Deliberately Distorting Exchange Rates ( http://bit.ly/Otm5OU), shows that it is possible.

Dr Basu writes that any foreign exchange player with deep pockets, moderate intelligence and unfussiness about moral scruples can make a profit by deliberately making exchange rates fluctuate.

The model

Dr Basu states that the foreign exchange market in most countries is made of few small, price-taking agents who transact in the market but do not impact the price. Then there are large strategic agents similar to Cournot firms that have homogenous products, do not collude, have market power and are profit-driven. Banks and other institutions that comprise the Foreign Exchange Dealers Association of India (FEDAI) are the strategic agents in India and individuals, tourists and so on are the price-taking agents.

The model shows that where all dealers are Cournot agents, it is possible for a manipulator to buy dollars and yet leave the exchange rate unchanged. He can create a strategy through which the dealers end up selling the quantity demanded by him at existing price.

In the next period, he can game the other dealers so that when they are encountered by the manipulator’s strategy combined with the net demand from price-taking agents, they move the price higher so that the manipulator can now sell at a price higher than that he originally purchased.

To put it simply, the manipulator works out how many dollars he will buy or sell at out of equilibrium price. Faced with these strategies, the dealers who are working in isolation to make profits, move the price in such a way that the manipulator profits.


According to Dr Basu, the intention of the paper is not to explain how currency manipulation is done. There are numerous ways to do that and there are players who are masters at the game. But regulators in most countries do not acknowledge the presence of manipulators nor do they understand the way the manipulator strategises. Deciphering these methods could help the regulators curb currency fluctuations without disturbing free functioning of market forces.

Currency futures

The RBI also appears to be thinking along similar lines. It had recently imposed limits on overnight open positions and intra-day open positions held by dealers in inter-bank forex market. This is among the first acknowledgement by the central bank that speculation could be one of the reasons for currency volatility.

There is an interesting observation towards the end of the paper that the manipulator can signal his intention to buy or sell at certain price through the currency futures market. There is also a suggestion that restrictions on futures trade can curtail the manipulator’s reach.

Towards the end of May, the RBI had stipulated that the forex positions on stock exchanges can not be netted by undertaking positions in the inter-bank forex market and vice-versa. Position limits were also imposed for banks for trading on exchange-traded futures and options segment. This move puzzled observers then.

The question this move raised was, whether manipulators were using currency futures to influence inter-bank forex prices. The RBI’s move seen against the backdrop of this paper suggests that the central bank concurs with the paper’s argument on currency manipulation through futures.  

The paper suggests that questions such as what would happen if more than one manipulator enters the market or how central bank interventions can neutralise these acts can be subjects for further research.

While the domestic inter-bank and exchange-traded forex market could be relatively easy to regulate, it is hard to see what the regulator can do if a manipulator operates from off-shore currency market such as the non deliverable forward market. It is no secret that a bunch of hedge funds and other entities trade this market with sophisticated strategies that regulators could find pretty difficult to unravel.

That said acknowledging the presence of currency manipulators is the first step. The Government and the RBI appear to be doing that now. The next step is to understand how it is done. This paper is one of the efforts towards that end. The final step would be to impose checks, as reining manipulation completely is next to impossible.  

Published on July 10, 2012

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