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Convertability, etc

On Sat, 15 Aug 1998, N. Arvind Kumar wrote:

> Hi Sanjeev,
> I have a question on Convertibility. I had
> actually posted aginst it hoping for a discussion
> so that I might be enlightened about points I might
> have missed. How is it beneficial? In the steady
> state, isn't the expected return from the system
> the same whether we have convertibility or not.

I'm not sure what you mean by that. The key issue is flexibility of the
exchange rate and preventing it from deviating too much from its intrinsic
value. You do not want to send wrong signals to anyone about the economy's
health, and flexible ERs do precisely that: send correct signals.
Convertibility on the current account might be a bit of a problem and so a
theory has built up around the 'sequencing of financial reform.' Pl. take
a look at a term paper that I wrote with Ramesh Nidugalla who teaches at
IIM Indore. Check out


There are many experts sitting on this list who might want to put in their
87 paise.

> It just seems to increase the amount of risk and
> rewards that one can get in one shot. It also
> opens the door to undesirable speculation.

Please do help me understand this one: "undesirable speculation." When is
it desirable and when is it not? I'm not comfortable with such terms since
I could never figure out why is an individual's personal choice to
speculate or not, something that you or I should pass judgment upon unless
it has quantifiable social costs. Most speculation is a zero sum game and
does not affect the economy either way. Might help reduce price
fluctuations, though. 

> On the other side, allowing convertibility freely
> might not at all have much negative effect. Even
> if we assume that people will convert to dollars,
> it will still be deposited in dollar deposits 
> within the country itself.

I would go only partly by that argument. In most collapsing economies,
people prefer to hold dollars. The only difference: these dollars are held
as dollars and not as deposits in banks, and thus, do not help the Central
Bank one bit. That is why sequencing is such an important issue. Strong
financial systems have to be in place first, plus good economic growth.
Then convertibility.

Where is it being said in the manifesto that we want a fully convertible
currency? If it is being said, we ought to re-think that issue.
> And on the question of sliding rupee, I have the
> following doubt. Why should it be welcomed as
> something that boosts exports? Isn't that a
> short sighted view? Let me explain my understanding.
> Please tell me what is wrong. Since the volume of
> goods that goes out increases but the total
> incoming ccurrency does not, it means that more
> goods is being produced but it is not being
> rewarded. So as a country we are poorer and
> suffering more.
> If a sliding rupee generates additional income
> in the days immediately following the slide,
> shouldn't that money be used to improve
> infrastructure so that in future we do not have
> to depend on a weaker rupee to improve exports.
> So why this rejoicing by exporters every time that
> rupee falls? Moreover a sliding rupee will 
> encourage flight of capital.

The deval. of the rupee is the natural consequence of the economic
policies we have followed which are known, in one word, as "socialism."
Continue down this path and India has no choice but to keep devaluing/
letting its rupee slide. (good for those of us who hold a few dollars,
though! Stay out of India for a while!) 

Devaluation is a sign of an economy's weakness. It is not a good thing per
se. It is an inevitable thing for weak economies. Did anyone say that on
the manifesto that it is a good thing? We must get rid of that too. 


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