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Trade and Exchange Rate Policy for India

Author(s): Amiya Kumar Bagchi and Prabirjit Sarkar


Source: Economic and Political Weekly, Vol. 28, No. 38 (Sep. 18, 1993), pp. 2012-2013
Published by: Economic and Political Weekly
Stable URL: http://www.jstor.org/stable/4400171
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DISCUSSION

iTade and Exchange Rate Policy for India advice to an Indiangovernment pursuing
what they regardas an essentially sound but
somewhat muddledsetof policies. Approv-
AmniyaKumar Bagchi
ing of the flexible exchange rateintroduced
Prabirjit Sarkar in India, they write, "There is no need to
fear that the exchange rate may fail as an
'IN the long runwe areall dead', thusspoke proposalsatall? Afterall, whetherwe agree instrumentto maintain a viable balance of
John MaynardKeynes. with the proposalsof thatcommitteeor not, payments-provided, of course, thatmacro-
'Follow us and you benighted worship- our agreement or disagreement must take economic policy gives it room to operate,
persof regulationforpublicgood, youshall into account the fact that the proposalsare that is, that there is no large general excess
live on milk and jioney, Coca Cola and meant for the actualsituationin Indiaright demand for domestic output". It appears
hamburgers-if you survivc', thus pro- now. Joshi and Little's arguments have from discussion elsewhere in their paper,
nounce Joshi and Little (1993). little bearing on the question of 'here and that by 'flexible exchange rates' Joshi and
It is difficult to make out whether one is now' in respect of policies governing im- Little really mean a policy of devaluation
surprised more by the innocence or the portregulation,exportpromotion,exchange whenever a balance of payments deficit
insouciance of the proposals of Joshi and rateregimes or budgetarypolicies. We will threatens and believe that a sufficiently
Little. The innocence is displayed by their demonstratethe irrelevance of Joshi and large devaluation of the rupee will always
apparent lack of awareness that anything Little's arguments in the area of the ex- cure a balance of payments deficit.
has happened, even in the area of main- changerateregimeand let the readersdraw The implicit claim in their paper that
stream economic theory, since the theo- the obvious parallelsin the case of the use before July 1991 India had maintained a
rems on the second best propounded by of other policy instruments. policy of fixed exchange rates is utterly
James Meade and Kelvin Lancaster and At the very outset of the oracularpro- false. The nominal exchange rate of the
Richard Lipsey. (Most of the Bhagwati- nouncement by Joshi and Little, we meet rupee(in rupeesper US dollar) was fixed up
Srinivasan or Little-Mirrlecs exercises are the following statement: "Sound macro- to June 5, 1966; then it was raised to Rs
simply variations on the second best theo- economic fiscal and monetarypolicies to- 7.50, andstayed at thatprice up to 1971-72,
ries of the welfare economics of the 1950s.) getherwith a flexible exchange rate,ensure but from 1972-73, the price rose almost
The innocence is also displayed by their the maintenanceof a viable overall balance steadily (with a break in the years from
apparentignoranceof what has happenedto with foreigners".This is a catch-all state- 1977-78 to 1980-81 when the rupeeappre-
Indianexchange rates,balanceof payments ment: apparentlyit should cover all pos- ciated in terms of US $ but not in terms of
andeconomicgrowth since the 1970s. (Note sible sins. For, after all, 'with sound mon- SDR) to Rs 8.968 in 1981-82 and Rs 17.943
that the only substantial references to their etary and fiscal policies', why should any- in 1990-91 [RBI 1993: Table 35]. Accord-
own work by Joshi and Little are to a book thing go wrong in the most perfect of all ing to a studyby H KPradhanundertakenon
published in 1970 and a paper publishedin possible worlds? But, in fact, Joshi and behalf of the Export-ImportBank of India
1971.) But perhaps the insouciance is even LittlearelivinginaMundell-Flemingworld. [EXIMBI 1992], the index of the realeffec-
more striking than the innocence. By sim- This is basically an 'insular economy' as tive exchange rate of the rupee (with base:
ply ignoring most of the actual problemsof defined by McKinnon (1981), in which 1980 = 100) with the w holesale price index
the Indianeconomy in the 1970s and 1980s, capital flows occur either on official ac- being used as the deflator for exchange
or the actual geopolitical setting of the count only, or passively in response to ratesof the majortradingpartners,declined
internationaleconomy, they come out with currentaccounts deficits. There is no place from 129.21 in 1970 to 81.36 in 1988 and
recommendationswhich would have glad- in thatworld for asset-owners deliberately with the consumer price index as the defla-
dened the heart of a FredericBastiat, a J R changing the composition of their portfo- tor, from 147.23 in 1970 to 81.80 in 1988
McCulloch or a Marquisof Salisbury. lios of domestic and foreign assets in re- [EXIMBI 1992: Table 5.9], that is, by 37
Given the fact thatmost of the arguments sponse to changes in their perceptions of per cent according to the first measure,and
of Joshi and Littlearebased on fantasy,they relative profitability of different types of by 44 per cent according to the second.
would hardly have been worth rebutting, assets. Thatis to say, it has no resemblance While a policy of devaluation according to
except for the fact that they are supposed to to the world that has emerged since the requirementsof internationalcompetitive-
have studied the problems of the Indian 1960s, of transnationalcorporations and ness or easing of current amount deficits
economy for quite a numberof years, and banks continually changingthe,composi- can certainly be adopted from time to time,
anything coming out of the west is consid- tion of theirportfolios and theiroperations there is little justification for a blanket
ered to be wisdom in official circles. as between assets denominatedin different espousal of a policy of devaluation as a
First of all, given the kind of assumption currenciesor locatedin differentcountries, basic remedy for balance of payment diffi-
that Joshi and Littlc make about the long or of large volumes of funds continually culties. At the riskof labouringthe obvious,
run,why slhouldthereheany tariffs(ofeven changing hands as between different na- the following points can be made in the
10 or 15 per cent) on imports into India at tions or regionsas speculators' moods and particularcontext of the Indian economy in
all? With free trade, free mobility of capi- judgments change. Virtually none of the recent times [Sarkar19921.
tal, free migrationof labourbetween differ- propositionson which theeasy assuranceof The hoped-for expansion in exports re-
ent countries, no problem of securing the the virtueof flexible exchange rates in en- sulting from currcncydevaluation may not
borders,no military threatsanywlhcre,and suring greater internal stability is based be realised because of well known factors
with minimal government, perhaps a poll remainunchangedin thisworldof globalised such as the inelasticity of global demandfor
tax on all working adults (and all able- capitalflows(see, forexample,Kenen1985; commodities, or competitive devaluation
bodied adultswould work in such a friction- and Frenkeland Mussa 1985). by othercompeting countries. The comput-
less, wisely governed world) would be But, of course, Joshi and Little descend ing of partialelasticities of demandwithout
enough. Then why do Joshi and Little from their preachers'pulpit to the posture taking such a possibility into account runs
bother to take up the Chelliah Comimittce of quotidianconsultantstcn(dcringfriendly up against the 'fallacy of composition'

2012 Economic and Political Weekly September 18, 1993


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Economic and Political Weekly September 18, 1993 2013