Note: Global Economic Intersection welcomes new contributor Dr. Ajay Shah, one of the leading economists in India. More biographical information is available at the end of this article.
Competitive currency manipulation is back on the front burner in the international policy debates, with many central banks edging towards trading on the currency market. Barring a few places like China, this has so far been a phoney war. But there is a genuine risk of undermining hard-won achievements of governments worldwide over the last 50 years in moving towards floating exchange rates.
A great deal of this debate centres on China which continues to have near-zero exchange rate flexibility. However, when we take a somewhat longer perspective, the exchange rate regime elsewhere in Asia has been moving towards greater flexibility.
Figure: Currency intervention by the Reserve Bank of India in each month, expressed as per cent of reserve money (M0)
India’s trajectory in the exchange rate regime has run in the reverse direction until recently. As the figure shows:
1. In 2007 and 2008, there was sustained buying of dollars in an attempt to hold down the rupee.
2. In March 2007, the erstwhile exchange rate regime broke down and a shift to greater rupee flexibility came about.
3. During the global crisis, there was one big month (October 2008) where $18 billion was sold.
4. Remarkably enough, from early 2009 onwards, RBI’s intervention has subsided. India is now on an unprecedentedly long period with a genuine floating exchange rate, where months have gone by without any transactions by the central bank.
In a gloomy international environment where governments are gearing up to do battle in currency markets, this stands out as a shift by an important emerging market away from government involvement in the exchange rate.
This shift in the policy stance has not been accompanied by high-minded policy statements explaining the rationale of what is being done. Indeed, no statements were made at all: It is only by analysing the data on exchange rate flexibility and on the transaction volumes of the central bank that we see a shift in stance.
Central banks should “say what you will do, and do what you just said”. The Indian RBI fails on both scores: neither was the intent of having a floating exchange rate announced, nor were the actions consistent with the stated rhetoric. RBI has invested no reputational capital in asserting that it prefers a market determined exchange rate and that it will withstand the political lobbying of exporters. No new policy stance has been announced, hence a discussion about the credibility of this stance cannot commence.
While RBI’s shift to zero trading is remarkable, there is some evidence that other Asian central banks have also been gradually evolving their exchange rate regimes away from the hypothesised ‘Bretton Woods II’ configuration. This is documented in The exchange rate regime in Asia: From crisis to crisis by Patnaik, Shah, Sethy, Balasubramaniam, International Review of Economics and Finance, 2010. If Asian central banks come back into exchange rate manipulation in late 2010, it would represent a reversal of a gradual process of moving away from government involvement in the currency market.