When I last wrote, some six weeks ago, I felt the issue was exhausted: I was badly wrong. Since then there have been notable additional contributions in this paper by Acharya, Bhalla, Lal, Mecklai, Shah, Rajwade and Subramanian, as well as other more infrequent contributors, such as Rajeev Malik of JPMorgan Chase in Singapore. Other Indian business papers are equally engaged.
This Indian debate is taking place concurrent with two related discussions in the international business Press [largely the Financial Times and The Economist]. These have to do with the lessons of the Asian financial crisis a decade after the devaluation of the Thai baht in 1997; and the unabated accumulation of foreign exchange reserves by China (which featured prominently but inconclusively in the recent "strategic dialogue" between the United States and China). Both these themes also dominated the intellectual discussions at the Annual Meetings of the Asian Development Bank in Kyoto early this month.
Related to this debate is the recent stunning decision by the Chinese authorities to take a significant equity position ($3 billion) in the Blackstone Group, as that major American private equity firm goes for a public listing. Now that the decision has been taken, and to no one's great surprise, a Chinese Vice-President of the Asian Development Bank, Liqun Jin, is quoted as saying approvingly, "Asian countries are exploring innovative ways to invest their reserves. Such diversity is welcome" (FT, May 25). Thus does bad policy feed upon itself.
China's move will further legitimise India's own scheme to make our foreign exchange reserves available for infrastructure financing, a scheme that was widely excoriated when floated by the Planning Commission two years ago but which now apparently has new domestic and international legitimacy. Indeed, a recent article in the FT has estimated that total funds at the disposal of what it labeled, "Sovereign Wealth Funds" to be as high as $2.5 trillion, about the size of the global hedge fund industry. The same article notes "in terms of disclosure on fund performance, investment strategy or even basic philosophy, many (sovereign wealth funds) rank below the most secretive hedge fund".
A few years ago the World Bank's research department published a book on state-owned enterprises entitled "Bureaucrats in Business," detailing the structural reasons that predisposed such entities to fail. While the private sector is also capable of stupendous errors, it is difficult to believe that bureaucrats in investment banking will fare much better. Temasek is still licking its wounds over its Thai investments while the world has forgotten the bath that the Malaysian central banking authorities suffered in adventurous management of their reserves some two decades ago. We ourselves seem too quickly to have forgotten our own Unit Trust of India debacle. Our Prime Minister, recently seized of the perils of crony capitalism, may wish to take note.
From the above it should be clear that my own basic position is unchanged, namely that excessive exchange market intervention to stabilise the nominal value of the rupee is undesirable and counter-productive, given the current state of the Indian economy and financial system. From that point of view, I am not dismayed by the recent rise of the rupee against the dollar. I do agree with Jamal Mecklai though when he says that the sudden shift in stance by the RBI (or, if one follows Surjit Bhalla, the Finance Ministry) may well have been more disruptive than a smoother transition.
I am also mindful, however, of the dictum that there are no absolutes in exchange rate regimes, and that the choice of regime depends on circumstances, both domestic and international. It is in this context that some of the recent contributions to the debate have been helpful and clarifying, both in and of themselves, and for drawing the distinction between our situation and that, say, of China.
Thus, Martin Wolf, reflecting on the Asian crisis, believes that the main lesson drawn by Asian policy makers was the compelling need to avoid currency overvaluation at all costs. But what is important is the further point that Martin makes: that most other Asian countries (most spectacularly China) have chosen to manage their fiscal and monetary policies so as to generate current account surpluses, even in the face of strong capital inflows.
This is essentially the same point that Deepak Lal makes in his column of May 15 when he argues that "the RER (real exchange rate: the relative price of tradeables to non-tradeables)... is an endogenous variable" determined by the overall effects of capital inflow, of monetary and fiscal policy, and the effects of terms of trade changes. I do not completely agree with Deepak, however, that the nominal exchange rate has no effect on the equilibrium RER, because if that were so then devaluations would not be part of a conventional stabilisation package.
In the light of the above, while I agree with Arvind Subramanian's analysis of the deferred fiscal cost of Chinese sterilisation, I have some difficulty in accepting his view that the Chinese real exchange rate is largely achieved through monetary manipulation. (I understand this also to be Surjit Bhalla's position.) I also have some difficulty reconciling this view with his later discussion of what he calls the "Bangalore Bug" (Dutch Disease in the tropics) which I also understand to be more a real rather than a monetary phenomenon, operating through the labour markets.
At the end of the day, capital inflows are just an additional source of financing of aggregate demand; the only real decision is whether they are to be absorbed or not, and whether the financial system can allocate them sensibly. If we wish to enjoy the benefits of an open capital account without a widening current account deficit, then, as Arvind Subramanian points out, fiscal policy needs to adjust. If we wish to absorb the foreign savings to boost investment then the relative price of non-tradables will need to rise, as Deepak Lal argues. All the important action is ultimately in the real economy. At the end of the day, money is a veil.
The author is Director-General, National Council of Applied Economic Research. The views here are personal.
