Exchange rate regimes of less developed countries: the case of India

Melazhakam, Mathew Joseph (1989) Exchange rate regimes of less developed countries: the case of India. PhD thesis, University of Glasgow.

Abstract

Although there exists a large volume of literature on the theory and practice of LDC exchange rate regimes in the post-Bretton Woods era, it is mostly of a general nature treating LDCs as a whole. There are very few studies which examine in depth the special features of individual exchange rate regimes. Moreover, the issue of exchange rate instability that characterized the generalized floating of world's major currencies since the early 1970s, has so far received only superficial treatments as far as LDCs are concerned. The thesis attempts to fill these gaps by examining the Indian case in detail. An exchange rate policy in fact has two aspects. First, it involves the establishment of an optimal exchange rate regime which lays the framework for the day-to-day determination of the nominal exchange rate. Second, the exchange rate policy is concerned with the operation of the exchange rate regime in such a way as to promote given policy objectives. In the context of generalized floating, the decision regarding exchange rate regime for an LDC has to be made on the grounds of `internal balance', i.e. with a view to protecting the domestic economy from disturbances arising from day-to-day third world currency fluctuations. This would require a multi-currency peg based on balance of trade elasticities. Once an exchange rate regime is established, it has to be managed on considerations of `external balance'. This in turn would require adjustments in the value of the peg, either to compensate for the inflation differential between the home country and its trading partners, or in order to bring about a balance of payments adjustment. India adopted a basket peg since September 1975. However, India's basket system does not appear to be optimal, firstly because of the major role given in it to sterling as the currency of intervention, designation and valuation, and more importantly, because the official currency basket does not seem to be representative enough and also is not based on elasticity weights. Concerning the management of the basket peg, it appears that the authorities have been guided by a number of alternative considerations which came into conflict with the objective of external balance. Particularly, considerations such as the minimization of speculation and inflation, and the stabilization of the rupee-dollar rate seemed to have considerably influenced India's exchange rate policy. An important result of the promotion of the above alternative objectives has been high exchange rate volatility. Exchange rate instability depresses trade by generating exchange risk. In the context of LDCs with quantitative restrictions on private imports and direct government imports, the impact of exchange risk is felt much more on exports than imports. Previous studies on the impact of exchange rate instability on LDC exports have suffered from specification mistakes of export functions as well as inaccuracy of the exchange risk proxies employed. We developed a fully specified exchange risk-augmented demand-supply model of exports for India. We used this model to estimate the impact of changes in exchange rate and exchange risk on exports in the aggregate as well as for the two disaggregated groups, namely, manufactured and non-fuel primary products. The separate effects on the volume and price of exports were estimated. We also demonstrated that the signs of the exchange risk elasticity coefficients in export price equations are consistent with the invoicing pattern of India's exports. We simulated the results of the export model under reasonable assumptions for the medium term, and demonstrated the possibility of much gains on current account through a policy of reducing exchange rate instability in real terms. They also tend to show that an equilibrium exchange rate cannot be defined independent of the short-term fluctuations of the exchange rate. The results of the study have profound implications also for other LDCs which are subject to chronic balance payment deficits.

• Item Type: Thesis (PhD)
• Qualification Level: Doctoral
• Subjects: H Social Sciences > HF Commerce
• Colleges/Schools: College of Social Sciences
• Supervisor's Name: Stevenson, Andrew
• Date of Award: 1989
• Depositing User: Ms Anikó Szilágyi
• Unique ID: glathesis:1989-5896
• Copyright: Copyright of this thesis is held by the author.
• Date Deposited: 09 Jan 2015 15:18
• Last Modified: 09 Jan 2015 15:20
• URI: https://theses.gla.ac.uk/id/eprint/5896