Wednesday, October 06, 2010

Is there a problem with rupee appreciation?

There is a lot of talk about capital inflows, rupee appreciation, concerns about export competitiveness, etc. It made me pull up the data to look at what is going on. The graph shows the nominal and real effective exchange rate of the rupee. The source is the BIS: the best computation of these indexes presently available.
Real and Nominal effective exchange rate of the Indian Rupee

There is one constraint of this data: it ends in August. The picture shown there is rather benign. Over the five year period shown in the graph, modest REER fluctuations are visible. Over the recent period of roughly a year, where RBI intervention has subsided, it isn't clear that something dramatic shifted.

And, I like to always remind everyone that the REER is a rather weak way to think about export competitiveness, so even if there was a sharp rise in the REER, we'd have to be cautious in rushing to conclusions about what it is saying.

The people making the case for currency trading by RBI have to cross four hurdles:
  1. Is there a crisis on export competitiveness that is rooted in exchange rate misalignment?
  2. How can controlling nominal things (the exchange rate) influence real things (the real rate)?
  3. Given a choice of using the tool of monetary policy for the purpose of delivering low and stable inflation (which benefits every citizen of India), versus the purpose of delivering some modification of the nominal exchange rate (which benefits a sectarian interest at best), what is the best choice?
  4. How can RBI be held accountable to maximise the interests of the people of India, if it is to do active trading on the currency market? What checks and balances, and what accountability mechanisms, need to be put into place in order to run a trading room in the government sector?
It is not so long ago (until early 2007) that RBI was actively trading in the currency market, championing the cause of India's exporters, and we saw how much trouble it got them in. In some ways, our inflation crisis today is the legacy of the unprecedented credit boom of the Y V Reddy years. Today's India is only more open than the India where Y V Reddy's regime tripped up on currency trading, so the challenges in embarking on that path today are even more daunting.

5 comments:

  1. Ajay, I am more surprised that the rupee has not appreciated against the dollar with the continued growth of the Indian economy and the weakness of the US and the continued endless printing that the us government has been doing.

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  2. I am not an economist. It would be great if you could explain how you believe that "our inflation crisis today is the legacy of the unprecedented credit boom".

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  3. Hi Ajay,

    I am just presenting my view would want to know your thoughts on this. In your article you have mentioned 4 hurdles before RBI should start trading actively :

    Is there a crisis on export competitiveness that is rooted in exchange rate misalignment?

    Ans : Yes. I will just take example of IT industry, why is the IT outsourcing growing. I can prove that its only growing because of cost arbitrage and nothing else by analysing the mix of business that these companies are doing. Post 2001, increasingly all the services companies are doing more and more of low end work like infrastructure management, manual testing services, secretarial work etc and less and less of application development and product development.

    How can controlling nominal things (the exchange rate) influence real things (the real rate)?

    Ans : I dont think for an exporter the REER has much value, because one he is impacted by excahneg rate and if he wants to hedge himself against volatility then the hedging products are based on exchange rate and not REER.

    Given a choice of using the tool of monetary policy for the purpose of delivering low and stable inflation (which benefits every citizen of India), versus the purpose of delivering some modification of the nominal exchange rate (which benefits a sectarian interest at best), what is the best choice?

    Ans: In your blogs, you have cited RBI's view on this. RBI itself does not want to be restricted to only inflation control and they do not want to be accountable to inflation control.

    How can RBI be held accountable to maximise the interests of the people of India, if it is to do active trading on the currency market?

    Ans : Because RBI concerns itself with maitaining growth in india, thus by definition it is accountable to maximize the interest of people.

    I dont know why they exist if they do not want to be accountable to either growth or to inflation.

    What checks and balances, and what accountability mechanisms, need to be put into place in order to run a trading room in the government sector?

    Ans : I think this is a second order quetion rather than a hurdle.

    Would look forward to see your thoughts.

    Thanks,
    Neeraj.

    ReplyDelete
  4. Recent news. Probably language won't translate into action.


    WASHINGTON: The Reserve Bank of India (RBI) would intervene in the foreign exchange market if its currency became too volatile or threatened to disrupt the economy , governor Duvvuri Subbarao said on Saturday.

    "If our understanding is that those conditions have been triggered, we will intervene," Subbarao told reporters after an emerging markets seminar hosted by the International Monetary Fund.

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  5. Hello Mr. Shah:

    I think the real problem lies in the export potential capability of Inida. As such there is no white paper on Inida's competitiveness in world to deliver and export like china or other . Also our investment into new science and technology related sector needs to be bolster to catch up in future ....

    More the infusion of pakage by Japanese and US will see cheap money flowing in as arbitrage carry forward.

    ReplyDelete

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