Letters: Devaluation logic

This refers to T N Ninan's column "Story of two devaluations" (Weekend Ruminations, August 17). The clinical analysis of the effects of the last two devaluations of the rupee should serve as an eye-opener to policymakers who seem to be struck by panic in the face of the rapid depreciation of the rupee during the past few weeks. Far from arresting the slide, rapid-fire measures such as capital controls are more likely to serve as red flags hindering foreign fund flows that can only make the situation worse.

Considering there are obvious limits to import compression, it is surprising that scarcely any attention is paid to boosting exports, that hold the key to the major problem of the current account deficit. The cynicism on the export front is so deep-rooted that no one in authority seems to recognise the recent spurt in exports as a turnaround, and much less as a welcome consequence of the depreciating currency.

I seek the indulgence of the author to point out here an arithmetical flaw that has crept in. Depreciation of the rupee from Rs 19.64 to a dollar in March 1991 to Rs 31.23 a year later meant a devaluation by 38.1 per cent and not 59 per cent - which was the extent by which the dollar appreciated against the rupee over that period. The fallacy in equating the depreciation of one currency with the appreciation in the other would be evident from a hypothetical example. If the rupee's value were to decline from 50 to 100 a dollar over a given period, the dollar would have appreciated by 100 per cent during that period, but the rupee would still be worth a cent at the end of that period, as against two at the beginning, signifying a 50 per cent depreciation (not 100 per cent!). As an extension, it can be seen that there is no limit to the extent by which one currency can appreciate against another, whereas no currency can depreciate by more than 100 per cent ever. By the same logic, it can be verified that the rupee was devalued in 1966 by 36.5 per cent and not 57.4 per cent, as stated.

Parthasarathy Chaganty Mumbai

T N Ninan replies: Mr Chaganty is of course right from his perspective, but there are two ways of looking at a devaluation. He seems to think only one is valid, whereas I think both are valid. It depends on your purpose.

The 1966 one was officially put at 36.5 per cent because the gold content was dropped from 18.xx units to 11.xx units, which was a drop of 36.5 per cent.

I chose to look at it differently, as follows: An exporter who sold a dollar worth of goods before the devaluation would have expected to get Rs 4.76. With the devaluation happening, he finally got Rs 7.50, which is 57.5 per cent more. Similarly, an importer who had ordered a dollar worth of imports, instead of paying Rs 4.76 as he might have thought, ends up paying 57.5 per cent more. So the market reality from Indian trade's point of view is 57.5 per cent, not the technicality of the gold content.

In fact, in the discussions in Washington on how much the devaluation should be, one question asked was whether 50 per cent would do - so at least some people deciding on the devaluation were also looking at it the way I have.

My method is not an "arithmetical flaw". It is a question of what your purpose is. In my context of looking at the price signal to Indian exporters and importers, I chose to look at it from their perspective.

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