The lineage in the C&F chapter I is quite clearly Dr Reddys famous Goa speech which I have been reiterating will go down in monetary history as a landmark which unshackled the RBI from conceptual problems and inhibitions. The reference in chapter I is a brief and clear factual statement of developments and the RBIs policy stance. But the writers of chapter X (who quite clearly are not the writers of chapter I) go off on a trip of their own. They must have got a great kick out of the newspaper reports which ran captions like Tarapore panel suggestion on rate band rejected (C&F, chapter X) and Tarapore defends RBI exchange rate policy symbiosis speech and then again RBI says rupee fall warranted by need to counter rise in REER (chapter I). Each of these newspaper reports is by itself correct but surely would have left the reader totally bewildered. The confusion is not caused by the journalists but by the not unusual disconnection between the RBI policy maker and the analyst.
In chapter I, (pages 1-9) the gradual depreciation of the rupee vis-a-vis the dollar between April and December 1997 is described as reflective of a correction of the cumulative real effective appreciation of the rupee by 12.7 per cent by August 1997. The RBI annual report, the speeches by the RBI management and the C&F chapter I carefully avoid any specific stand on the recommendation of the Committee on Capital Account Convertibility (CAC) on a real effective exchange rate (REER) monitoring band.
The C&F chapter X, however, undertakes a frontal attack on the committees recommendations when it argues that .. in view of the complexities involved in exactly identifying the cause of the equilibrium rate, there is a suggestion for the use of bonds to represent fundamentals, but this would be inappropriate on credibility grounds. Chapter X goes on to say: A band could be arrived at by constructing a panel of REER indicators, each representing adjustment of effective nominal exchange rate movements for changes in relative prices, productivity differentials/differences, prices of tradeables and non-tradeables, interest rate differentials in financial asset prices, tariff and non-tariff reforms, improvements in payments and settlement systems affecting transaction costs etc.... in view of the difficulties associated with the construction of several REER indicators, the central banks intervention strategy should primarily be to ensure an orderly exchange market condition by containing excessive volatility.
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Chapter X goes on to say that the CAC committees recommendation would suggest a rolling neutral base... the success of the suggested band, however, would be contingent upon the attainment of all the preconditions/signposts on a sustained basis. In the face of large destabilising capital flows and /or periodic deviations from norms suggested as precondition, rigid pursuance of such a band could, however, be costly and distortive.
A columnist writing in a financial daily has concluded that the exchange rate monitoring band has been given the official burial. If chapter X is really the RBI official view, so be it! But in a world of allowing a hundred flowers to bloom, I wonder whether this is really so. I doubt whether the policy and operations of the RBI in the area of exchange rate management could be determined even remotely by what is set out in chapter X, pages 11-12. One fails to see what is meant by construction of a panel of REER indicators or the construction of several REER indicators, using things as tariff and non-tariff refor-ms and payment and settlement systems.
The CAC committee had never suggested the construction of such scatter-brained REER indicators and to argue against the committees proposal on the ground that such indicators are difficult to construct is a non sequitur. Surely, the RBIs intervention strategy cannot be determined on the premise that weird REER panels set out in chapter X cannot be constructed and, therefore, the RBIs strategy should primarily be to ensure an orderly exchange market condition by containing excessive volatility. There surely has to be a better rationale for exchange rate policy.
Again, chapter X makes the stultifying statement that the exchange rate band is contingent on all the preconditions/signposts being attained. It is unclear what it intends to say. Does it wish to say that there can be no exchange rate policy until all the preconditions are satisfied? This is a poor apology for chapter X not setting out an alternative.
We need to assess chapter X in the light of developments in the exchange market since the middle of August 1997. With a REER appreciation of 14 per cent and the turbulence caused by newspaper reports on the imminence of a monitoring band, the RBI was right to soft pedal on the issue. But with the subsequent depreciation of the rupee and the continuing low inflation rate, it would be clear that a significant part of the REER adjustment has taken place. It would thus now be quite possible to examine the feasibility of the REER monitoring band. If the authorities are averse to a monitoring band they need to come up with an alternative credible policy.
I find myself in the unenviable position of being openly in sympathy with the actual exchange rate policy and operations but totally out of sync with the party theoreticians of the RBI as reflected in chapter X. I have a sneaking suspicion that the RBI top management would also be uncomfortable with chapter X. I have great empathy with the RBI dilemma. It is rather akin to the conflict between the first generation hard working simple old Indians who have migrated to the US and their children who are popularly called ABCDs (American-Born Confused Desis). As Keynes said, it is ideas not vested interest which is ultimately dangerous for good or evil. The RBI needs to sort out its kids without discouraging them from exercising their arms and legs. Poor kids!