In continuation of the recent focus on interest rate differentials and their consequences for upholding a pegged exchange rate, Ila Patnaik has an interesting article which makes two points:
- Remittance inflows seem to be roughly of the same range of values as net capital flows. It is well known that a lot of remittances are actually capital flows: a person working abroad sends money to India to his relatives who get invested here.
- Eyeballing the time-series seems to show a strong relationship between remittances and the interest rate differential.
This considerably enlarges our sense of how much capital is or can come into India in response to one-way bets. Conversely, if we set out to capital controls, then these will have to extend to remittances also. Else, money that is blocked as capital inflows will merely show up as remittances. Hmm, and if capital controls are placed against remittances, then passangers will need to be frisked at airports, because a kilogram of gold is roughly the size of a box of cigarettes. X-ray machines will detect a kilogram of gold? A cigarette-box filled with one-carat diamonds is worth roughly 2 million dollars.
Here's an amusing aside on Indian monetary policy. At a meeting at the Planning Commission, the policy debate on Indian monetary policy was reduced to the three corners of the impossible trinity:
- Some people favour closing down the capital account, so as to have pegged exchange rate + monetary policy autonomy (e.g. Shankar Acharya)
- Some people favour pegging the exchange rate with an open capital account, saying that the loss of monetary policy autonomy is harmless (e.g. Surjit Bhalla)
- Some people favour an open capital account with a floating exchange rate, which buys monetary policy autonomy (e.g. Suman Bery, Ila).
A remarkable feature of the present situation is: People at all three corners agree on one thing: RBI should cut rates now! :-)