Ila Patnaik has written about five predictions made by Larry Summers in a talk about the evolution of the international financial integration of India and China:
- Capital account convertibility: Regardless of what policy makers in these countries want, there will be a deepening financial integration, owing to growing trade, investment and capital flows.
- Reserves accumulation: The increasing financial integration would not be accompanied by the current pace of foreign exchange reserves accumulation in terms of the reserves to GDP ratio. Why? At some point, the US government will not want to be massively indebted to the governments of India and China.
- INR and CNY appreciation:The next decade would witness an appreciation of the real exchange rates of the two countries.
- INR and CNY volatility: Exchange rates in India and China will be more flexible than they are today because of the difficulties of managing domestic monetary policy when exchange rates are being manipulated.
- Current account deficits: India and China would move from current account surpluses to structural current account deficits, reflecting the superior marginal product of capital in these countries.
At present, RBI seeks the other direction on all five counts. It fears convertibility, accumulates reserves in implementing a de facto pegged exchange rate, prevents a real appreciation, lacks a exit path towards a flexible exchange rate, and lacks a game plan for a sustainable current account deficit. So all five predictions are contrary to what RBI is trying. But Larry Summers is offering predictions, not policy recommendations. He feels that these outcomes will emerge regardless of what policy makers seek to achieve.
I see the unfolding story in the same way: these changes are inevitable. As I have written on the subject on convertibility, our choice is between handling these changes in a graceful and choreographed way, or in an inept and bumbling fashion.