This, however, goes against the current ideology of the International Monetary Fund (IMF) — and the US. A case which illustrates the issue is the state of the Japanese economy and the deflationary pressures it has been facing. After its recent review of Japan’s economy, the IMF advised policymakers to adopt an incomes policy under which wages should rise three per cent a year, in order to help meet the targeted inflation rate. Obviously, intervention in the real economy is virtuous but intervention in the currency markets is not. The US also has recently warned Japan against intervention in the currency market to depreciate the yen to help meet its inflationary target. On the other hand, China is looking at measures, including the imposition of a “Tobin tax” on short-term, speculative transactions. (Such a transaction tax is named after Nobel Laureate James Tobin, who first proposed it more than three decades back, in order to reduce speculation in currency markets — the suggestion went nowhere as the financial sector lobbied strongly against it.)
The contrast between the way the IMF/US look at Chinese and German surpluses is indicative of how ideological the issue has become. China was criticised for long for its huge trade surplus and accused of currency manipulation to get unfair advantage; it has since brought the surplus down significantly through a managed appreciation of its currency. On the other hand, Germany’s surplus is a record 8.5 per cent of gross domestic product, helped by a currency undervalued in real, that is, inflation-adjusted, terms by 30 per cent (World Bank estimate). But it is not criticised because the exchange rate is market-determined.
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As far as emerging economies in general are concerned, Reserve Bank of India former governor Raghuram Rajan had argued in a 2014 speech at the Brookings Institution in Washington that the advanced countries are engaged in “competitive monetary easing” in order to drive capital to emerging economies and appreciate their currencies. On the other hand, there is little empirical evidence to suggest that domestic monetary policies have a predictable influence on the currency’s exchange rate, whatever the media headlines. Japan is a good example. Since well before the financial crisis of 2008, Japanese monetary and fiscal policies have been extremely loose. And yet the currency had reached a then record high of something like JPY80 per dollar, even before Lehman. This once again emphasises that the only way in which a central bank can effectively manage the exchange rate is through intervention in the market.
Every intervention need not be considered as being tantamount to manipulation of the exchange rate, if the aim is to reduce the external imbalances on flow (primary income and expenditure) and/or stock (international investment position) account. This would suggest that our central bank needs to actively intervene in the market to depreciate the rupee, and not merely to curb volatility.
Coming back to the question of slowdown in trade growth, apart from volatile exchange rates, there are other reasons as well. For one thing, lower commodity prices, particularly oil, the world’s most traded commodity, mean that the dollar value of trade comes down. Free trade agreements across the Atlantic and Pacific oceans are bogged down. Another major threat to world trade could well be the election of Donald Trump as the next president of the Unites States in less than two weeks from now — though the prospect seems unlikely at the time of writing.
The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwade@gmail.com