## Wednesday, June 16, 2010

### Structural change in the Indian exchange rate regime

The rupee/dollar rate has gained in flexibility. In order to visualise what has changed, it's useful to look at a graph of the time-series of weekly percentage changes, expressed in absolute terms. That is, a change of -3% or +3% is shown as a bar of height 3 in this graph:

The vertical blue lines show the dates of structural change in the exchange rate regime. These are taken from our recent paper The Exchange Rate Regime in Asia: From Crisis to Crisis, which is forthcoming in International Review of Economics and Finance, and is part of our work on measurement of the de facto exchange rate regime. As an aside, a recent article in The Economist about Asian currency flexibility talks about this in a larger context.

The vertical blue lines break the overall experience into six distinct periods: a first period of high flexibility, then the shift to a nearly fixed rate in April 1994, then the higher flexibility at the time of the Asian crisis followed by a return to very low flexibility, and then two moves of increasing flexibility.

These movements towards flexibility -- and away from administered prices -- require corresponding adjustments on the part of the economy. If firms are coddled with an administered price and thus think that currency risk does not exist, or if exporters are coddled with a distorted exchange rate, then this generates the wrong behaviour on their part. See Ila Patnaik in the Indian Express on learning to live with a genuinely market determined exchange rate. Also see T. B. Kapali, of the Shriram Group of Companies, in the Hindu Business Line arguing in favour of greater flexibility for corporations in hedging currency risk.

Please note: LaTeX mathematics works. This means that if you want to say $10 you have to say \$10.