The Indian currency has been under pressure for the past few months, having lost 13 percent since February. Earlier this week, it hit an all-time low of 56 rupees to the dollar in intraday trading. This weakness comes partially from the shift of global investors to “risk-off” mode, retrenching in fear of a European mess. But it primarily reflects bad economic policy in India that has scared away investment (investment in both the economic, building-a-factory sense and the financial, buying-a-stock sense).
One policy that India has gotten right since 2008 is allowing the rupee to essentially float with the market. As described in my column published today in The Financial Express, this approach gives India a useful automatic stabilizer and frees monetary policy to focus on the domestic economy rather than managing the exchange rate. (A few unlucky Rice University undergrads will cover this issue in much more depth in my International Finance course in the fall.)
Many emerging market countries don’t allow their currencies to move much, with China being the prime example. And, in India, the (managed) floating rupee policy is not well-entrenched. Policymakers don’t like the short-run impact when their exchange rates move, even if the adjustments are healthier in the long run. And for certain types of economies — not India or China, though — a floating exchange rate might not make sense.
Given that India’s central bank is exposed to criticism for a smart policy, it is important to bolster their position with public arguments.
- Read “The paradox of forex reserves” in the May 23, 2012, online edition of The Financial Express.
Russell A. Green, Ph.D., is the Will Clayton Fellow in International Economics at the James A. Baker III Institute for Public Policy. Green spent the past four years in India, where he served as the U.S. Treasury Department’s first financial attaché to that country. His engagement in India primarily focused on financial market development, India’s macroeconomy and illicit finance, but included diverse topics such as cross-border tax evasion and financing global climate change activities.