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POLITICALLY
CORRECT
Let
The Market Decide
The
Government should target inflation and leave the exchange rate to the
market
By
P. Chidambaram
 In
January 1998, during the run up to the general elections, Sushma Swaraj
made the extraordinary statement that if the BJP came to power at the
Centre, the government would bring the dollar:rupee rate to Rs 17. I was
amused, but I let it pass. A few days later, Atal Bihari Vajpayee made
a similar statement in Lucknow. This time I was not amused and telephoned
my friend Jaswant Singh. Jaswant got the point and promised to have a
quick word with Vajpayee. Vajpayee never mentioned the exchange rate again
in his
campaign.
That was candidate Vajpayee. Now, he is prime minister, and prime ministers
are easily moved into believing that the measure of the government's performance
is the exchange rate and that too the rate against the almighty US dollar.
Prime ministers, I think, want a correct exchange rate, and correct
in their dictionary means stable. I do not know what the prime
minister thinks of the recent sharp decline in the exchange rate but I
get the impression that the BJP is unhappy. So must be some NDA constituents.
When in the opposition, these parties, BJP included, used the depreciation
of the rupee against the dollar as a stick to beat the government. Now,
they see themselves at the receiving end.Since
they did not understand what an exchange rate was when attacking the government
of the day, these parties do not know how to defend themselves when in
government.
The exchange
rate is a price, the price to be paid for one US dollar. Likewise, there
is a price for one British pound, one euro or one Japanese yen. The price
depends upon many factors, the chief among them being demand and supply.
The Indian rupee has indeed depreciated against the dollar: in January
1999, you could buy a dollar for Rs 42.52. In June 2000 you would have
needed Rs 44.69. Since then, the rupee has depreciated further. On the
other hand, what is not widely noticed is that, during the same period
(January 1999 to June 2000), the Indian rupee gained against the British
pound from Rs 70.16 to 67.43 and against the German mark from Rs 22.27
to 22.26. The gain against the euro was the sharpest, from Rs 49.40 in
January 1999 to Rs 39.93 in May 2000, an appreciation of nearly 25 per
cent, but it fell again in June 2000.
A weakening
of the rupee will indeed raise some costs, for example, the cost of imports,
of travel and of tuition abroad. On the other hand, it will also benefit
some sections like importers. For manufacturers, the effective tariff
protection will go up. Thus, there will be both winners and losers. Other
countries too have witnessed currency gyrations. The yen has swung between
90 and 160 to a dollar. The British pound was mauled a few years ago.
None of these countries became poorer solely because of changes in the
exchange rate. They attended to their fundamentals and have become stronger
economies. That is what we should do. If there is a wrong public perception
about the exchange it is because of two reasons. The first is the failure
of the political leadership to grasp the issues concerning the exchange
rate and communicate the same to the people. The second is because two
major players, the Finance Ministry and the RBI, have different objectives.
As the central bank, the RBI is charged with the duty to maintain price
stability. Not that the RBI has always been focused on targeting inflation,
but that is its dharma. The Finance Ministry is, I suspect, more concerned
with interest rates. The lowering of interest rates earlier this year
was at the instance of the Finance Ministry and because it was keen not
to dampen the revival of industrial growth.
Is it then a case of the three key players pursuing different objectives
- the RBI targeting inflation, the Finance Ministry targeting interest
rates and the PMO targeting the exchange rate? I am not sure there is
a clear answer now, or there ever was. In the ultimate analysis, it would
be sound policy for the government as a whole to target inflation. It
is inflation that affects the largest number of people in different ways,
and the poor suffer the most.
The interest
rate should be seen as an instrument to fight inflation and, by and large,
the exchange rate should be left to the market. Only rarely should the
RBI resort to the money and measures method of intervention.
There are
other ways to impart stability to the exchange rate. Increasing inflows
of foreign investment every year have multiple benefits and the immediate
impact will be on the exchange rate. The BJP-led Government's track record
in actual FDI flows has been dismal: $2.48 billion in 1998-1999 and $2.17
billion in 1999-2000. If Vajpayee leads his team in attracting FDI his
woes, if any, about the exchange rate will disappear.
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The
stock markets are humming, and it's feel-good time once again, writes
INDIA TODAY Associate Editor V. Shankar Aiyar in 
