While going through the Leaders’ Statement at the end of the G-20 Pittsburg Summit, I was struck by the fact that the leaders of the 20 largest economies of the world commented on the need for “reforming compensation practices to support financial stability”. (The paragraph lists out half a dozen principles for this purpose.) That bank traders’ compensations need to be deliberated by the Summiteers is a travesty and a manifestation of how perverted the balance of power between the financial economy and the real economy has become, an indication how powerful finance has become, how it has increasingly become the master rather than the servant of the real economy!
The “market always right, intervention wrong” economic philosophy propagated by the Chicago School of market fundamentalism, which got popularity in certain quarters after the advent of Mrs. Thatcher in U K and Mr Reagan in the US, finally culminated in the financial crisis of 2007-08, which has cost these two countries the maximum. While there are some signs that the worst may be over for the global economy, others argue that we could go back into another recession when the monetary/fiscal stimulus stops and, indeed, would need to be reversed.
But coming back to finance as the master, too many Finance Ministers are afraid to take any steps which would roil financial markets; indeed, a bullish reaction from the stock market is considered a test of the economic policies, and vice versa. (Remember what happened when the previous Governor suggested that, at some stage, it may become necessary to consider restrictions on capital inflows? The stock market swooned and, within hours, the then Finance Minister promptly overruled the Governor’s very mild suggestion. My memory is that the related portion of the Governor’s speech was deleted even from the RBI’s website!) The immediate provocation for these thoughts is how, at the highest levels, the RBI continues to mouth what has by now become a cliché: that it intervenes in the exchange market only to curb extreme volatility, that it has no particular level in mind and that the rate is market determined — no matter that the IMF considers India’s exchange rate policy to be one of “managed floating”. The coyness about admitting that the rate is managed is perhaps a manifestation of how we have been brainwashed over the last 30 years by the Chicago School.
The question is whether the half-truths, so useful in answering questions and making statements, have not started affecting the exchange rate policies of the central bank. In the last seven months, the rupee has appreciated 11 per cent in nominal terms against the dollar, the currency in which more than 80 per cent of our external transactions are invoiced. (The real appreciation is more, if the retail price inflation is considered as it should be; on it depend wages and hence costs in the tradeable sector.) True, part of the reason for the rupee’s rise is the dollar’s fall globally. And, in index terms, the rise may be less. (But, to my mind, the index itself suffers from two weaknesses: trade-based, rather than invoicing currency-based, weights; and the use of WPI, rather than RPI, in calculating the index.) But, this apart, the contrast with the rest of developing Asia is worth emphasising:
Even the nominal appreciation is the second highest (next only to Indonesia);The rest of developing Asia records surpluses on the current account; we have a deficit.
China has kept the exchange rate rock steady through this period. It obviously gives far more importance to domestic jobs and growth than to the sanctity of a market-determined exchange rate.
Such comparisons with the rest of Asia apart, the appreciating currency (which is a deflationary measure) is not in consonance with the stimulative monetary and fiscal stance. And, it is coming precisely at a time when there are some signs of revival in the global trade!
I have long argued in this column my belief in a managed exchange rate, aimed at competitiveness of the domestic economy. If there are problems in managing the exchange rate needed for a reasonable balance on the current account (net of remittances), because of capital inflows, the correct course is to curtail the latter: too many countries have suffered by allowing the currency to appreciate because of capital flows, and the current account deficit to become unsustainable (Mexico 1994-95, East Asia 1997-98, Argentina 2001). None of them thought that they could have a crisis until it occurred — nor, of course, do we. In short, the exchange rate is too important a price to be left to the vagaries of capital flows.
Tailpiece: One of the commitments of the G 20 Summiteers is “To phase out and rationalise over the medium term inefficient fossil fuel subsidies while providing targeted support for the poorest. Inefficient fossil fuel subsidies encourage wasteful consumption, reduce our energy security, impede investment in clean energy sources and undermine efforts to deal with the threat of climate change”. I am looking forward to our government following up on the commitment by eliminating the subsidies on petro-products.
Happy Samvat 2066.
