FOREX & ECONOMY

Couple of days or last week while browsing in net I got this article, I think in FINANCIAL EXPRESS (I am not sure). I thought its good article to share with you guys.

Any Indian economist traveling abroad now is likely to be asked 2 questions. First, what is the economic impact of terrorist strikes? Second, what is India’s role in resolving the global financial crisis, or for that matter, in the G-20? On the former, the answer certainly is, minimal and transient. On the second, the answer probably is, minimal and more permanent. After the G20 meeting, a newspaper reported that Saudi Arabia, China and Japan offered money, while India offered advice. That’s understandable. We aren’t in the same league. After the US-triggered crisis hit us, there has been some depletion in reserves. But cross-country figures are only available for 2007. Then, India’s reserves were $253bn, compared to $1905bn for China, $997bn for Japan, $555bn for the Euro-zone, $485bn for Russia and $343bn for Saudi Arabia.

Expressed as share of GDP, India’s (23%) forex reserves look even smaller, with 58.2% for China, 37.6% for Russia, 89.6% for Saudi Arabia, 73.6% for Taiwan and 108.7% for Singapore. Within WTO, India does matter. But outside WTO, the point is limited to East Asia. But tomorrow, given expected growth trajectories, South Asia, Latin America and even Africa will have to be factored in. Some economic problems China confronts today are symptomatic of what India may have to confront tomorrow.

First, there is the savings/investment mismatch. Before financial crisis hit the world, global macro economic imbalances had been talked about ad nauseam. This meant high savings rates in East Asia (and China), low savings rates in the US, current account deficits in the US and current account surpluses in East Asia. Each side blamed the other. But no one did anything as long as US consumption kept the world growth engine chugging along. There used to be talk of two models of development, China’s investment driven and India’s consumption-driven. However, there has been convergence. Not only have investment rates gone up to 36% of GDP in India. So have savings rates, to almost 34%, a function of demographic shifts and income growth. Consumption plateaus. A population ages. Hence, in countries where extensive social security doesn’t exist, savings rates inch up. If all goes well, there is no reason why India shouldn’t have large current account surpluses.

Where will we invest surpluses? In the US, in the Euro zone or in East Asia? Second, what will be our exchange rate policy? We have excess reserves because of mindsets about foreign exchange being scarce, crude imports, conditions imposed at times of borrowing by IMF and perceived lessons gleaned from 1990-91 and East Asian financial crisis. However, even allowing for uncertainty, we don’t need reserves more than $50bn. If a country performs well and grows, there is no way to prevent currency appreciation.

Intervention which prevents this isn’t cost-less, particularly when it is oneway non-transparent intervention. Forex markets don’t develop, people take one-way bets, there is excess liquidity and capital is driven abroad. That’s one reason why capital flowed to US, despite low interest rates there.

There is now talk of Bretton WoodsII. But no international institution barring WTO has any teeth. Nor will IMF have any teeth unless US and Europe let go of that institution, without suggesting creation of new institutions. One can’t have a world where fast growing developing economies have fixed exchange rates, while developed countries are on flexible ones. But when national sovereignty and policy making choice are perceived to be at stake, there is no international organization today that can push this agenda. That’s the reason we need to sort out these two issues (savings/investment and exchange rate) internally, without external triggers. Listing these two separately is also symptomatic of distortions we are starting with.