January 8, 2006 — drsubrotoroy
The Dream Team: A Critique
by Subroto Roy
First published in The Statesman and The Sunday Statesman, Editorial Page Special Article, January 6,7,8, 2006
(Author’s Note: Within a few weeks of this article appearing, the Dream Team’s leaders appointed the so-called Tarapore 2 committee to look into convertibility — which ended up recommending what I have since called the “false convertibility” the RBI is presently engaged in. This article may be most profitably read along with other work republished here: “Rajiv Gandhi and the Origins of India’s 1991 Economic Reform”, “Three Memoranda to Rajiv Gandhi”, “”Indian Money & Banking”, “Indian Money & Credit” , “India’s Macroeconomics”, “Fiscal Instability”, “Fallacious Finance”, “India’s Trade and Payments”, “Our Policy Process”, “Against Quackery”, “Indian Inflation”, etc)
1. New Delhi’s Consensus: Manmohantekidambaromics
Dr Manmohan Singh has spoken of how pleasantly surprised he was to be made Finance Minister in July 1991 by PV Narasimha Rao. Dr Singh was an academic before becoming a government economic official in the late 1960s, rising to the high office of Reserve Bank Governor in the 1980s. Mr Montek Singh Ahluwalia now refers to him as “my boss” and had been his Finance Secretary earlier. Mr Ahluwalia was a notable official in the MacNamara World Bank before being inducted a senior government official in 1984. Mr P Chidambaram was PVNR’s Commerce Minister, and later became Finance Minister in the Deve Gowda and Gujral Governments. Mr Chidamabaram is a Supreme Court advocate with an MBA from Harvard’s Business School. During 1998-2004, Dr Singh and Mr Chidambaram were in Opposition but Mr Ahluwalia was Member-Secretary of the Vajpayee Planning Commission. Since coming together again in Sonia Gandhi’s United Progressive Alliance, they have been flatteringly named the “Dream Team” by India’s pink business newspapers, a term originally referring to some top American basketball players.
Based on pronouncements, publications and positions held, other members or associates of the “Dream Team” include Reserve Bank Governor Dr YV Reddy; his predecessor Dr Bimal Jalan; former PMO official Mr NK Singh, IAS; Chief Economic Advisers Dr Shankar Acharya and Dr Ashok Lahiri; RBI Deputy Governor Dr Rakesh Mohan; and others like Dr Arvind Virmani, Dr Isher Ahluwalia, Dr Parthasarathi Shome, Dr Vijay Khelkar, Dr Ashok Desai, Dr Suman Bery, Dr Surjit Bhalla, Dr Amaresh Bagchi, Dr Govind Rao. Honorary members include Mr Jaswant Singh, Mr Yashwant Sinha, Mr KC Pant and Dr Arun Shourie, all economic ministers during the Vajpayee premiership. Institutional members include industry chambers like CII and FICCI representing “Big Business”, and unionised “Big Labour” represented by the CPI, CPI(M) and prominent academics of JNU. Mr Mani Shankar Aiyar joins the Dream Team with his opinion that a gas pipeline is “necessary for the eradication of poverty in India”. Mr Jairam Ramesh explicitly claimed authoring the 1991 reform with Mr Pranab Mukherjee and both must be members (indeed the latter as Finance Minister once had been Dr Singh’s boss). Dr Arjun Sengupta has claimed Indira Gandhi started the reforms, and he may be a member too. External members include Dr Jagdish Bhagwati, Dr. TN Srinivasan, Dr Meghnad Desai, Dr Vijay Joshi, Mr Ian Little, Dr Anne O. Krueger, Dr John Williamson, IMF Head Dr R Rato, and many foreign bank analysts who deal in Bombay’s markets. Harvard’s Dr Larry Summers joins with his statement while US Treasury Secretary in January 2000 that a 10% economic growth rate for India was feasible. His Harvard colleague Dr Amartya Sen — through disciples like Dr Jean Dreze (adviser to Sonia Gandhi on rural employment) — must be an ex officio member; as an old friend, the Prime Minister launched Dr Sen’s recent book while the latter has marked Dr Singh at 80% as PM. Media associates of the Dream Team include editors like Mr Aroon Purie, Mr Vinod Mehta, Dr Prannoy Roy, Mr TN Ninan, Mr Vir Sanghvi and Mr Shekhar Gupta, as well as the giddy young anchors of what passes for news and financial analysis on cable TV.
This illustrious set of politicians, government officials, economists, journalists and many others have come to define what may be called the “New Delhi Consensus” on contemporary India’s economic policy. While it is unnecessary everyone agree to the same extent on every aspect — indeed on economic policy the differences between the Sonia UPA and Vajpayee NDA have had to do with emphasis on different aspects, each side urging “consensus” upon the other — the main factual and evaluative claims and policy-prescriptions of the New Delhi Consensus may be summarised as follows:
A: “The Narasimha Rao Government in July 1991 found India facing a grave balance of payments crisis with foreign exchange reserves being very low.”
B: “A major cause was the 1990-1991 Gulf War, in its impact as an exogenous shock on Indian migrant workers and oil prices.”
C: “The Dream Team averted a macroeconomic crisis through “structural adjustment” carried out with help of the IMF and World Bank; hence too, India was unaffected by the 1997 ‘Asian crisis'”.
D: “The PVNR, Deve Gowda, Gujral and Vajpayee Governments removed the notorious license-quota-permit Raj.”
E: “India’s measurable real economic growth per capita has been raised from 3% or lower to 7% or more.”
F: “Foreign direct investment has been, relative to earlier times, flooding into India, attracted by lower wages and rents, especially in new industries using information technology.”
G: “Foreign financial investment has been flooding into India too, attracted by India’s increasingly liberalised capital markets, especially a liberalised current account of the balance of payments.”
H: “The apparent boom in Bombay’s stock market and relatively large foreign exchange reserves bear witness to the confidence foreign and domestic investors place in India’s prospects.”
I: “The critical constraint to India’s future prosperity is its “infrastructure” which is far below what foreign investors are used to in other countries elsewhere in Asia.”
J: “It follows that massive, indeed gargantuan, investments in highways, ports, airports, aircraft, city-flyovers, housing-estates, power-projects, energy exploration, gas pipelines, etc, out of government and private resources, domestic and foreign, is necessary to remove remaining “bottlenecks” to further prosperity for India’s masses, and these physical constructions will cause India’s economy to finally ‘take off’.”
K: “India’s savings rate (like China’s) is exceptionally high as is observable from vast expansion of bank-deposits, and these high (presumed) savings, along with foreign savings, will absorb the gargantuan investment in “infrastructure” without inflation.”
L: “Before the gargantuan macroeconomic investments bear the fruits of prosperity, equally large direct transfer payments also must be made from the Government to prevent mass hunger and/or raise nominal incomes across rural India, while existing input or other subsidies to producers, especially farmers, also must continue.”
M: “While private sector participants may increasingly compete via imports or as new entrants in industries where the public sector has been dominant, no bankruptcy or privatisation must be allowed to occur or be seen to occur which does not provide public sector workers and officials with golden parachutes.”
Overall, the New Delhi Consensus paints a picture of India’s economy on an immensely productive trajectory as led by Government partnered by Big Business and Big Labour, with the English-speaking intellectuals of the Dream Team in the vanguard as they fly between exotic conferences and international commercial deals. An endless flow of foreign businessmen and politicians streaming through Bangalore, Hyderabad, five-star hotels or photo-opportunities with the PM, followed by official visits abroad to sign big-ticket purchases like arms or aircraft, reinforce an impression that all is fine economically, and modern India is on the move. Previously rare foreign products have become commonplace in India’s markets, streets and television-channels, and a new materialist spirit, supposedly of capitalism, is captured by the smug slogan yeh dil mange more (this heart craves more) as well as the more plaintive cry pardesi jana nahin, mujhe chhorke (foreigner, please don’t leave me).
2. Money, Convertibility, Inflationary Deficit Financing
India’s Rupee became inconvertible in 1942 when the British imposed exchange controls over the Sterling-Area. After 1947 independent India and Pakistan, in name of “planned” economic development, greatly widened this war-time regime – despite the fact they were at war now only with one another over Jammu & Kashmir and, oddly enough, formed an economic union until 1951 with their currencies remaining freely convertible with each other.
On May 29 1984, the present author’s Pricing, Planning and Politics: A Study of Economic Distortions in India proposed in London that the Indian Rupee become a convertible hard currency again — the first time liberal economics had been suggested for India since BR Shenoy’s critique of the Second Five Year Plan (a fact attracting an editorial of The Times). The simple litmus test whether believers in the New Delhi Consensus have or have not the courage of their stated convictions – i.e., whether what they have been saying is, in its empirical fundamentals, more signal or noise, more reality or rhetorical propaganda – would be to carry through that proposal made 21 years ago. The Dream Team have had more than enough political power to undertake this, and it remains the one measure necessary for them to demonstrate to India’s people and the world that the exuberant confidence they have been promoting in their model of India’s economy and its prospects is not spurious.
What does convertibility entail? For a decade now, India has had limited ease of availability of foreign exchange for traders, students and tourists. Indeed some senior Government monetary economists believe there is convertibility already except forex dealers are being allowed “one-way” and not “two-way” quotes! That is wrong. The Government since 1942 has requisitioned at the border all foreign exchange earned by exporters or received as loans or investment — allocating these first to pay interest and amortisation on the country’s foreign debt, then to make its own weapons and other purchases abroad, then to release by ration what remains to private traders, students, tourists et al. Current account liberalisation has meant the last of these categories has been relaxed, especially by removal of some import quotas. What a convertible Rupee would mean is far more profound. It would allow any citizen to hold and save an Indian money that was exchangeable freely (i.e. without Government hindrance) into moneys of other countries. Full convertibility would mean all the paper money, bank deposits and rupee-denominated nominal assets held by ordinary people in India becomes, overnight, exchangeable without hindrance into dollars, yens, pounds or euros held anywhere (although not of course at the “one-way” rates quoted today).
Now money is a most peculiar human institution. Paper money is intrinsically worthless but all of India’s 1,000 million people (from street children onwards) have need to hold it temporarily to expedite their individual transactions of buying and selling real goods and services. Money also acts as a repository of value over time and unit of account or measure of economic value. While demand to hold such intrinsically worthless paper is universal, its supply is a Government monopoly. Because Government accepts obligations owed to it in terms of the fiat money it has itself issued, the otherwise worthless paper comes to possess value in exchange. Because Government controls its supply, money also can be abused easily enough as a technique of invisible taxation via inflation.
With convertibility in India, the quantity of currency and other paper assets like public debt instruments representing fiscal decisions of India’s Union and State Governments, will have to start to compete with those produced by other governments. Just as India’s long-jumpers and tennis-players must compete with the world’s best if they are to establish and sustain their athletic reputations, so India’s fiscal and monetary decisions (i.e. about government spending and revenues, interest-rates and money supply growth) will have to start competing in the world’s financial markets with those of the EU, USA, Japan, Switzerland, ASEAN etc.
The average family in rural Madhya Pradesh who may wish, for whatever personal reason, to liquidate rupee-denominated assets and buy instead Canadian, Swiss or Japanese Government debt, or mutual fund shares in New York, Frankfurt or Singapore, would not be hindered by India’s Government from doing so. They would become as free as the swankiest NRI jet-setters have been for years (like many members of the New Delhi Consensus and their grown children abroad). Scores of millions of ordinary Indians unconnected with Big Business or Big Labour, neither among the 18 million people in government nor the 12 million in the organised private sector, would become free to hold any portfolio of assets they chose in global markets (small as any given individual portfolio may be in value). Like all those glamorous NRIs, every Indian would be able to hold dollar or Swiss Franc deposit accounts at the local neighbourhood bank. Hawala operators worldwide would become redundant. Ordinary citizens could choose to hold foreign shares, real-estate or travellers’ cheques as assets just as they now choose jewellery before a wedding. The Indian Rupee, after more than 65 years, would once again become as good as all the proverbial gold in Fort Knox.
When added up, the new demand of India’s anonymous masses to hold foreign rather than Rupee-denominated assets will certainly make the Rupee decline in price in world markets. But — if the implicit model of India’s economy promoted by the Dream Team is based on correctly ascertained empirical facts — foreign and domestic investor confidence should suffice for countervailing tendencies to keep India’s financial and banking system stable under convertibility. Not only would India’s people be able to use and save a currency of integrity, the allocation of real resources would also improve in efficiency as distortions would be reduced in the signalling function of domestic relative prices compared to world relative prices. An honest Rupee freely priced in world markets at, say, 90 per dollar, would cause very different real microeconomic decisions of Government and private producers and consumers (e.g., with respect to weapons’ purchases or domestic transportation, given petroleum and jet fuel imports) than a semi-artificial Rupee at 45 per dollar which forcibly an inconvertible asset in global markets. A fully convertible Rupee will cause economic and political decisions in the country more consistent with word realities.
Why the Rupee is not going to be made convertible in the foreseeable future – or why, in India’s present fiscal circumstances if it was, it would be imprudent to do so – is because, contrary to the immense optimism promoted by the Dream Team about their own deeds since 1991, they have in fact been causing India’s monetary economy to skate on the thinnest of thin ice. Put another way, a house of cards has been constructed whose cornerstone constitutes that most unscientific anti-economic of assumptions, the “free lunch”: that something can be had for nothing, that real growth in average consumption levels of the masses of ordinary households of rural and urban India can meaningfully come about by nominal paper-money creation accompanied by verbal exhortation, hocus-pocus or abracadabra from policy-makers and their friends in Big Business, Big Labour and the media. (Lest half-remembered inanities about “orthodox economics” come to be mouthed, Maynard Keynes’s 1936 book was about specific circumstances in Western economies during the Depression and it is unwise to extend its presumptions to unintended situations.)
3. Rajiv Gandhi and Perestroika Project
On 25 May 2002, India’s newspapers reported “PV Narasimha Rao and Manmohan Singh lost their place in Congress history as architects of economic reforms as the Congress High Command sponsored an amendment to a resolution that had laid credit at the duo’s door. The motion was moved by…. Digvijay Singh asserting that the reforms were a brainchild of the late Rajiv Gandhi and that the Rao-Singh combine had simply nudged the process forward.”
Now Rajiv Gandhi was an airline-pilot and knew no economics. But the origins of the 1991 reform did come about because of an encounter he had, as Opposition Leader and Congress President from September 1990 onwards, with a “perestroika” project for India’s political economy occurring at an American university since 1986 (viz., The Statesman Editorial Page July 31-August 2 1991, now republished here; Freedom First October 2001). In being less than candid in acknowledging the origins of the reform, the Dream Team may have failed to describe accurately the main symptoms of illness that afflicted India before 1991, and have consequently failed to diagnose and prescribe for it correctly ever since.
The Government of India, like many others, has been sorely tempted to finance its extravagant expenditures by abusing its monopoly over paper-money creation. The British taught us how to do this, and in 1941-43 caused the highest inflation rates ever seen in India as a result. Fig. 1 shows this, and also that real growth in India follows as expected the trend-rate of technological progress (having little to do with government policy). Independent India has continually financed budget- deficits by money creation in a process similar to what the British and Americans did in wartime. This became most conspicuous after Indira Gandhi’s bank and insurance nationalisations of 1969-1970. Indeed, among current policy-makers, Pranab Mukherjee, Manmohan Singh, Arjun Sengupta, Montek Singh Ahluwalia, Bimal Jalan, NK Singh, Amaresh Bagchi and Shankar Acharya, were among those governing such macroeconomic processes before 1991 — albeit in absence of the equations that illustrate their nature. Why the Rupee cannot be made an honest, internationally convertible, stable money held with confidence by all Indians today, is because the Dream Team have continued with the same macroeconomics ever since. The personal and political ambitions of the tiniest super-elite that the New Delhi Consensus represent (both personal and political) have depended precisely on gargantuan unending deficit-financing backed by unlimited printing of paper-money, and hence the continuing destruction of the integrity of India’s banking system. A convertible Rupee would allow India’s ordinary people to choose to hold other stores of value available in the world today, like gold or monies issued by foreign governments, and thus force an end to such processes.
Two recent articles in The Statesman (Perspective Page 30 October 2005, Front Page 29 November 2005) outlined India’s financial repression and negative real interest rates (which suffice to explain the present stock market boom the way athletes perform better on steroids), and also how deficits get financed by money creation accompanied by wishful projections of economic growth in an upside down imitation of how macroeconomic policy gets done in the West.
“Narrow Money” consists mostly of hand-to-hand currency. “Broad Money” consists of Narrow Money plus bank-deposits. Modern banking is built on “fractional reserves”, i.e. a system of trust where your bank does not literally hold onto deposits you place there but lends these out again – which causes further deposit expansion because no individual banker can tell whether a new deposit received by it is being caused by the depositor having himself borrowed. As a general rule, bank lending causes further deposit expansion. Why India’s (and China’s) bank deposits have been expanding is not because Indians (or Chinese) are superhuman savers of financial assets in banks but because the Government of India (and China) has for decades compelled (the mostly nationalised) banks to hold vast sums of Government debt on the asset side of their balance-sheets. Thus there has been humongous lending by the banking system to pay for Government expenditures. The Dream Team’s macroeconomics relies entirely on this kind of unending recourse to deficit finance and money creation, causing dry rot to set into banks’ balance sheets (Figs. 2,3, 4). If the Rupee became convertible, those vast holdings of Government debt by banks would become valued at world prices. The crucial question would be how heavily New York, London and Hong Kong financial markets discounted Indian sovereign debt. If upon convertibility, the asset sides of domestic Indian banks get discounted very heavily by world financial markets, their insolvency upon being valued at international prices could trigger catastrophic repercussions throughout India’s economy. Hence the Rupee cannot be made convertible — and all our present inefficiencies and inequities will continue for ever with New Delhi’s rhetorical propaganda alongside. The capital flight of 10 out of 1000 million Indians will continue, leaving everyone else with the internal and foreign public debts to pay.
4. A Different Strategy had Rajiv Not Been Assassinated
Had Rajiv Gandhi not been assassinated and the perestroika project allowed to take its course, a different strategy would have been chosen. Honest money first demands honest Government and political leadership. It would at the outset have been recognised by Government (and through Government by all India’s people) that the asset-liability, income-expenditure and cash-flow positions of every public entity in the country without exception — of the Union Government, every State and local Government, every public undertaking and project – is abysmal. Due to entanglement with government financial loans, labour regulations, subsidies, price controls, protection and favouritism, the same holds for the financial positions of vast numbers of firms in the organised private sector. Superimpose on this dismal scene, the bleak situation of the Rule of Law in the country today – where Courts of Justice from highest to lowest suffer terrible abuse receiving pitiable amounts of public resources despite constituting a third and independent branch of India’s Government (while police forces, despite massive expenditure, remain incompetent, high-handed and brutal). What India has needed ever since 1991 is the Rule of Law, total transparency of public information, and the fiercest enforcement of rigorous accounting and audit standards in every government entity and public institution. It is only when budgets and financial positions become sound that ambitious goals can be achieved.
The Dream Team have instead made a fetish of physical construction of “infrastructure”, in some grandiose make-believe dreamworld which says the people of India wish the country to be a superpower. The Dream Team have failed to properly redefine for India’s masses the appropriate fiscal and monetary relationship between State and citizen – i.e. to demarcate public from private domains, and so enhance citizens’ sense of individual responsibility for their own futures, as well as explain and define what government and public institutions can and cannot do to help people’s lives. Grotesque corruption and inefficiency have thus continued to corrode practically all organs, institutions and undertakings of government. Corruption is the transmutation of publicly owned things into private property, while its mirror image, pollution, is the disposal of private wastes into the public domain. Both become vastly more prevalent where property rights between private and public domains remain ill demarcated. What belongs to the individual citizen and what to sovereign India –their rights and obligations to one another – remains fuzzy. Hence corruption and pollution run amuck. The irrational obsession with “infrastructure” is based on bad economics, and has led to profoundly wrong political and financial directions. The Rupee cannot be made an honest stable money because India’s fiscal and monetary situation remains not merely out of control but beyond New Delhi’s proper comprehension and grasp. If and when the Dream Team choose to wake up to India’s macroeconomic realities, a great deal of serious work will need to be done.
October 27, 2005 — drsubrotoroy
Waffle but No Models of Monetary Policy:
The RBI and Financial Repression (A Stock Market on Steroids)
First published in The Statesman, Perspective Page, October 27 2005
If the average Indian citizen feels flummoxed at hearing all the fancy words from official spokesmen and the talking heads on TV and the expensive pink business newspapers — words like “credit offtake”, “liquidity”, “reverse repo rate” “medium term”, “inflation mandate” etc — there is help at hand. It is as likely as not that the purveyors are as flummoxed themselves even while they bandy these terms about in what has been passing for monetary policy in India in recent years. No one has any reliable economic models backed by time-series data to support all the waffle.
Here is an example.
The Government (and specifically the department of the Finance Ministry known as the RBI) will have us believe that the decline in the value of money that has been occurring in India has been at less than 5% per annum. According to official figures, the average Indian’s purchase of consumable goods and services (food, housing, clothing, transport etc) has been costing more every year by merely 5% at the very most. “What you can buy for Rs. 1000 in one year, you have to pay just Rs 1050 to buy the next year” is what the Government will have us believe. But is anyone’s personal experience of the diminishing value of the domestic currency in India consonant with what official spokesmen say inflation happens to be?
You may well reply that you cannot quite recall what Rs. 1000 bought for you last year. Precisely so. Nor really can anyone else — and that mutual collective loss of memory on the part of the public is something that India’s Government (like many other governments across time and space) has been literally banking on!
Consider a few very simple calculations. Suppose a citizen earns an annual income of Rs. 100,000, and an honest Government told him/her to pay total taxes (from both income and expenditure) of 10%. Clearly Rs. 90,000 would be left for the citizen to spend on his/her various choices of consumption or saving afterwards. If the citizen could assume the value of money was constant (inflation was 0%) then this Rs. 90,000 in one year would buy the same amount of goods and services the next year. But instead we may be living in a political system where the Government officially taxes very lightly, and then dishonestly taxes very heavily by reducing the value of money invisibly, i.e. by inflation. The Government may make the official tax-rate 8% and the actual inflation-rate 15%. The citizen who has Rs. 100,000 will then pay Rs. 8,000 in nominal taxes, but the Rs. 92,000 that is nominally left over for his own consumption and savings, will be made to decline by a further 15% every year.
I.e., a further value of Rs.13,800 (15% of Rs. 92,000) would effectively disappear as an invisible tax from the household budget due to the decline in the value of money, without the household being any wiser. In real terms, the household would have only Rs. 78,200 left.
Where would that extra value disappear to? Clearly, the beneficiary of this invisible extraction of real resources from household budgets would be the only entity that is able to compel the decline in the value of money, namely, the Government, which holds monopoly power to print the pieces of paper (at zero cost) that we call “money” and which we are forced by circumstances to use to expedite our real transactions of goods and services. Roughly speaking, that is how the Government’s own budget deficit gets financed in India.
I.e., the Government of India has its own (massive) expenditures — not merely on things like roads and bridges and military tanks and submarines, but also on ministers and bureaucrats’ wages etc., besides enormous interest payments on past debts incurred by the Government. If the expenditures exceed the visible revenues raised from taxation, as they have done by perhaps 40-50% or more every year for several decades, then the difference gets bridged by printing more paper money over which the Government has had a monopoly.
In India, a total of perhaps 18 million people work in all branches of government and a total of perhaps 12 million people work in the entire organised private sector. That makes 30 million people — with 4 dependants each, that accounts for perhaps 150 million people in the country. That leaves another 850 million people in our population of 1,000 million. Everyone, whether in the 150 million or the 850 million, rich and named or poor and anonymous, has had to use for his/her real transactions of goods and services the paper that the Government produces as money. By causing a decline in the value of this paper every year by x%, everyone who holds this paper, as well as assets denominated in this paper, suffers an invisible taxation of x% without quite realising it. The real revenue the Government of India extracts in this way is what has allowed it to balance its own books.
Furthermore, in the Indian case, what is said to be the inflation-rate and the actual inflation-rate experienced by ordinary people, may well be two different things. The wage-bill of those 18 million people employed by government agencies are linked directly to what official spokesmen say the inflation-rate is, so if the actual rate being experienced was higher and was announced as such, so would have to be that wage-bill and public expenditure! Official spokesmen may tell us the decline in the value of money has been merely 5% or less a year, so what cost Rs. 1000 last year costs Rs. 1050 this year, but as a matter of plain fact, the average citizen’s experience (and memory) may well tell him/her something different – e.g. that what cost Rs. 1000 last year, is in fact costing Rs. 1100 or Rs 1150 or Rs 1200 this year.
So much for the value of money. Now turn to interest-rates.
Here too, the average citizen need not be a rocket-scientist to know that relative to the Western countries, India is labour abundant and is capital scarce. Roughly speaking, that means we have relatively more people and fewer high-rise concrete buildings than the West does. Where then would you expect wages (the price of labour) to be higher, in the West or in India? Clearly in the place where labour is more scarce, namely, the West. And where would you expect interest-rates (the price of capital) to be higher? Clearly, where capital is relatively more scarce, namely India. Such was clearly the case between 1864 and 1926 (Fig. 1). Calcutta bank interest-rates were uniformly higher by about 2-3% than London bank interest-rates (in an era of zero inflation). But something wholly different occurred in the pseudo-socialist India after Independence. E.g., for the years 1975-1992 official Indian interest-rates (adjusted for inflation) were uniformly lower than those in world capital markets represented by the USA (Fig. 2). That remains true today. Not only have the higher wages of the West been attractive to Indians, so seems to be the higher real rates of return on capital! Hence everyone who could fled India – exporting their adult children and their savings abroad , leaving future generations of the anonymous masses with larger public debts to pay the bills in due course. There has been a flight of skilled labour and as well as capital flight from India — are foreigners going to come when they can see the Indian “elite” has fled? Official real interest-rates in India today may well be negative if inflation is properly measured, which would explain the Bombay stock-market boom the same way an athlete can perform better when on steroids.
Of course in the unorganised capital markets, actual real rates of return have always been higher in India than in the West and remain so. Just ask anyone in the unorganised capital markets how much he has to pay to rent machinery on a daily basis e.g. in the building or construction trade in an Indian city or small town or village. He will quote you rates of 2% or 5% or 10% — per day. Hence there is a massive distortion between what is happening in the unorganised capital markets all over the country and the official money markets the RBI believes itself to be presiding over in Bombay. Until the RBI starts to tell us frankly about this phenomenon, which is known to economists as “financial repression” and which has been caused by runaway Government spending programmes in India for decades, the average citizen may discount all the talk about a few basis points changing here and there on this or that nominal rate, in our pale imitation of what we think the US Fed or the European or British central banks do as policy. The truth is the RBI has never been allowed to model itself after those institutions. Instead, India has had nationalised commercial banking whose pampered inefficient management and staff have allowed the holding of massive amounts of government debt as assets in their balance-sheets, all denominated in an inconvertible controlled currency, and all presided over by a “one-tier” central bank patterned on the old Gosbank of the former Soviet Union, completely subservient to the dictates of the runaway spending that this or that particular set of politicians in power may demand. If there are dreams to be dreamt by honest economists in India, it would be for all that to be made to change.
June 4, 1993 — drsubrotoroy
Path of the Bangladesh Taka 1972-1993
Subroto Roy 1993
Note: This was part of a 1993 study I did as a consultant at the IMF in Washington in a project on exchange-rates and exports of “South Asian” countries. The IMF is not responsible for its content.
“Bangladesh, being the former East Pakistan, shared the same currency and trade-policy history as the rest of Pakistan until the Bangladesh taka was created on January 1 1972. Pakistan rupees in circulation remained legal tender until replaced by the taka 1:1 beginning March 4 1972.
The taka was set at par with the Indian rupee, and fixed to sterling at Tk 18.9677, or Tk 7.2797 to the United States dollar. The path followed by the taka was determined partly by the initial value chosen for the new currency in 1972. Given the devastation experienced by the Bangladesh economy from natural disaster, civil war and war in 1969-1971, the initial value chosen for the taka on par with the Indian rupee was in all likelihood unrealistic, even more so to the extent the Indian rupee was itself nominally overvalued at the time.
Since that time, the principal fact about official exchange-rate policy in Bangladesh has had to do with overseas workers’ remittances far exceeding any single sector of merchandise exports as a support for the balance of payments. A multiple exchange-rate system prevailed with a secondary market as an incentive for overseas workers to remit through official channels instead of at parallel or “hundi” market-rates, the spread between the parallel and official channels being exceptionally high for Bangladesh compared to India and Pakistan. IMF technical studies laid the groundwork for abolishment of the multiple exchange-rate practice and the unification of exchange-rates, which was accomplished on March 31 1992.
The path of the official taka is informative as a measure of nominal overvaluation. Since August 1979, the official taka has been pegged within margins to a currency-weighted basket. The taka was adjusted as many as 20 times between October 1980 and January 1982, the official rate being reduced to Tk. 38.4 to sterling or Tk.20.4 per United States dollar. In January 1983, the weights were changed and in March 1985 changed again. On this basis, the nominal effective exchange rate depreciated by 29 percent and the real effective exchange rate by 21 percent between August 1979 and December 1982. From February 1985, exchange-rate policy has with IMF support tried to keep in mind an upper limit on the real effective exchange, the nominal rate declining in one year by 20 percent and the real rate by 22 percent. From the end of 1985 through November 1988, there was further depreciation of 4 percent. In absence of further nominal depreciation, combined with further deterioration of the domestic price-level, the real exchange rate appreciated by 7 percent between November 1988 and April 1989, followed by further appreciation of over 9 percent during May-June 1989. A revised index confirmed the loss of competitiveness, indicating at least 12 percent real appreciation by end June 1989 relative to 1988. From November 1988 to February 1990, the taka remained at Tk 32.27 per United States dollar with the official secondary market 2 percent higher. In 1990 the rates were depreciated six times by a total of 11 percent, corresponding to 8 percent real depreciation. The official taka was at Tk.36.49 per United States dollar as of July 7 1991. Recent Bangladesh exchange-rate policy has seemed to be guided by such considerations, and has not been responsive to regional developments such as changes in the Indian rupee.”
June 3, 1993 — drsubrotoroy
Path of the Sri Lankan Rupee 1948-1993
Subroto Roy, 1993
Note: This was part of a 1993 study I did as a consultant at the IMF in Washington in a project on exchange-rates and exports of “South Asian” countries. The IMF is not responsible for its content.
“The Ceylon rupee traded 1:1 with the Indian rupee at the time of Independence and devalued with sterling and the Indian rupee in September 1949 to Rs.4.76 per United States dollar. It was pegged to sterling throughout the Bretton Woods period at that value. Sri Lanka did not respond to the Indian devaluation of 1966 but when sterling devalued in November 1967 from $2.80 to $2.40, the Ceylon rupee was devalued by 20 percent to Rs.5.95 per United States dollar. In May 1968, a dual exchange-rate system was introduced with the official rate of Rs. 5.95 applying to official capital transactions, traditional exports of tea, rubber and copra, and imports of foods, drugs and fertilizers. Other importers and non-traditional exports faced an exchange-rate of Rs. 8.57 per United States dollar, devalued to Rs. 9.23 in June 1969.
Following the end of the Bretton Woods mechanism in August 1971, the Ceylon rupee appreciated because of its peg to sterling. As with India and Pakistan, the link to sterling was soon broken, and in November 1971 the Ceylon rupee was pegged to the dollar, thereby depreciating with the dollar. The peg was at the same official rate of Rs. 5.95 as previously. As with India and Pakistan, it is possible that long-term damage was done to Sri Lanka’s competitiveness relative to other developing countries in the Bretton Woods period by overvalued nominal exchange-rates associated with inward looking trade policies.
When sterling floated in June 1972, Sri Lanka delinked from the dollar and pegged at Rs. 15.60 to sterling, until May 1976 when the rupee was delinked again from sterling and pegged to an undisclosed basket of currencies. In a major reform in November 1977, the multiple exchange-rates were unified and the Sri Lankan rupee was devalued by more than 46 percent to Rs. 16 per United States dollar, which was maintained until the first half of 1980. The rupee depreciated further to Rs. 18.01 per United States dollar by the end of 1980, and to Rs.18.35 by May 1981. Relative to a weighted average of the currencies of Sri Lanka’s major trading partners (including India and Pakistan) the rupee depreciated by 14 percent from November 1977 through July 1980 and a further 10 percent by December 1980. But due to higher Sri Lankan price-level changes, this may have been associated with appreciation of the real exchange-rate.
From August 1983, a formal system was adopted attempting to target the real-exchange rate, by which the rupee would be adjusted periodically depending on domestic price-levels relative to Sri Lanka’s six main trading partners (Britain, the United States, India, Japan, Germany and France). In practice, the Sri Lankan authorities took other factors into account, “most notably exchange-rate movements of the currencies of neighboring as well as competitor countries”. The first half of the 1980s were marked by real exchange-rate appreciation by as much as 30 percent, especially against the currencies of Sri Lanka’s neighbours and competitors including India and Pakistan. In 1985, the rupee depreciated by more than 9 percent in nominal terms and more than 15 percent in real terms, including against India and Pakistan, but this decline did not fully offset the loss of competitiveness in 1981-1984.
Since 1986, the real effective exchange-rate has fluctuated substantially. Between 1986 and mid-1989 it depreciated by over 10 percent, when a large nominal depreciation in September 1989 contributed to further depreciation of the real rate. Subsequently, the real rate appreciated by about 17 percent between late-1989 and early-1991, following which further nominal depreciation contributed to gradual real depreciation through mid-1992.
Technical studies at the IMF laid the groundwork for a floating market-determined exchange-rate for Sri Lanka based on a daily interbank market. Sri Lanka introduced such a system in August 1990, whereby the authorities were to set daily buying and selling rates as intervention points and permit the spot exchange rate to be determined within them. This system began to work effectively with an adequate difference between the intervention points in March 1992. The Sri Lankan rupee, at Rs. 44.6 per United States dollar in December 1991 and Rs. 46 in December 1992, was at Rs. 47.5 in April 1993. The Indian exchange-rate reforms of 1992-1993 have been observed closely by Sri Lankan authorities, and in late March 1993, Sri Lanka removed all remaining barriers to current account convertibility.””
June 2, 1993 — drsubrotoroy
Path of the Pakistan Rupee 1947-1993
Subroto Roy, 1993
Note: This was part of a 1993 study I did as a consultant at the IMF in Washington in a project on exchange-rates and exports of “South Asian” countries. The IMF is not responsible for its content.
“The Pakistan rupee traded 1:1 with the Indian rupee at the time of Independence. As noted, Pakistan chose not to devalue with sterling and the Indian rupee in 1949, which led to the end of the common market which existed with India. Almost six years later, on July 31 1955, Pakistan with IMF approval devalued to Rs.4.76 to the United States dollar, again establishing the same par-value as India.
Pakistan did not respond to the 1966 Indian devaluation although the Pakistan economy had suffered similar shocks, especially the 1965 war with India and natural disasters and civil conflict in East Pakistan. On July 22 1970, a fluctuating tourist rate was introduced, effecting a partial devaluation. Demonetization of bank-notes in June 1971 and the civil conflict leading up to the December 1971 Bangladesh war led to considerable capital flight via the well-developed parallel market where the Pakistan rupee reportedly touched Rs. 25 to the United States dollar.
Following the breakdown of the Bretton Woods mechanism as of August 1971, the official Pakistan rupee began to appreciate because of its peg to sterling. In September, Pakistan like India changed its peg from sterling to the dollar, thereby depreciating with the dollar. But Pakistan stayed at the same rate that had been established since 1955 of Rs.4.76 per United States dollar. As with India, it is possible that in the period 1949-1979 long-term damage was done to Pakistan’s competitiveness relative to other developing countries by highly overvalued nominal exchange-rates associated with an inward-oriented trade regime.
In May 1972, Pakistan implemented a major exchange reform, unifying existing multiple exchange-rates and declaring a new par value of Rs.10 to the United States dollar, which implied a 130 percent nominal devaluation and 62 percent real devaluation. After a small appreciation in 1974, the rupee was maintained at Rs. 9.9 to the United States dollar for the next nine years. However, the real exchange rate appreciated by an estimated 20 percent in the first half of the 1970s, and then depreciated by about 8 percent in the second half of the 1970s. Domestic inflation relative to foreign inflation caused further loss of competitiveness as the real rate appreciated by nearly 10 percent in 1981-1982. Although the authorities were aware of a loss of competitiveness, they were unwilling to devalue the nominal rate for almost a decade.
Faced with a severe balance of payments situation, Pakistan in January 1982 finally abandoned the fixed peg with the United States dollar and pegged to an undisclosed currency basket with the dollar retained as the intervention currency. The rupee was depreciated by nearly 20 percent in 1982-1983 and a further 11 percent in 1983-84, with real exchange-rate depreciations of 11 percent and 4.6 percent respectively. A substantial improvement was recorded in the current account especially on workers’ remittances (accounting for almost the same as the entire merchandise exports of Pakistan) which rose by 30 percent over the 1981-82 level. The nominal depreciation slowed in 1984-85, with slight real rate appreciation. This became reflected in the current account with workers’ remittances showing a remarkable elasticity and falling by almost $300 million. In 1985-86, the nominal exchange-rate was allowed to depreciate at a more accelerated pace.
The influence on Pakistan’s exchange-rate policies of India may be separated into different factors. Pakistan’s initial decision in 1949 not to follow the devaluation of sterling and the Indian rupee was seen by contemporary observers as a statement of national sovereignty by the new country. However, the detrimental consequences of this led six years later to Pakistani devaluation to the same par-value as India at Rs.4.76 per United States dollar. Pakistan did not respond to India’s 1966 devaluation to Rs.7.50 to the United States dollar, and the Pakistani devaluation of 1972 to Rs.10 to the United States dollar was a change of policy specifically in the new circumstances following the 1971 war with India over Bangladesh. The 1972 devaluation was in all likelihood long overdue, since, as already noted, both Pakistan and India may have sustained long-term damage during the Bretton Woods period from overvalued nominal exchange-rates in face of numerous economic shocks, especially natural disasters and wars with one another.
In relation to their mutual hostilities, overvalued nominal exchange-rates in India and Pakistan have been of course conducive to each country’s defence sector imports, although at the cost of mutual loss of competitiveness for export and other hard-currency earning sectors of in the world economy.
Pakistan did not nominally depreciate any further in the 1970s despite real exchange-rate appreciation. The delinking from the United States dollar and the start of active depreciation did not begin until January 1982. Whether this was coincidence or a response to the fact that India actively began to depreciate at the end of 1981 is hard to tell. In any case, the Pakistan rupee and Indian rupee both depreciated almost in tandem during most of the 1980s The extent of similarity was tested when the Indian rupee moved in the range of -1 to 1 percent, 1-2 percent on either side, and more than 2 percent on either side. The greater the change in the Indian rupee’s bilateral exchange-rate with respect to the United States dollar, the larger the extent of similarity in movement between the Pakistan rupee and the Indian rupee. In the Indian case, the large likely influence of the United States dollar has been noted, with the Indian currency depreciating less fast when the dollar was appreciating with respect to other major currencies than when the dollar was depreciating with respect to other major currencies in the 1980s. The Pakistan rupee seemed to be maintained in the 1980s at a significantly competitive rate with respect to the Indian rupee — e.g. at 1.32 per Indian in 1986, 1.34 in 1987, 1.30 in 1988, 1.27 in 1989 and 1.24 in 1990. This indicates a distinct change from the 1949 situation when resisting devaluation was seen as a statement of national sovereignty.
The large Indian devaluations of 1991 left the Pakistan rupee at 1.06 per Indian, and in 1992 at 0.97. The major changes which have taken place in the Indian exchange-rate regime in 1992 and 1993 have been followed closely by the Pakistan authorities and public.”