Ok this is one of those things i’m not too good at. So I request you to comment on my reasoning.
1. They say that exports should be balanced by imports. That exporting is useless unless you use the FX to import stuff. Now, how does China manage to hold its exchange rate despite the massive current account surpluses that it has? It imports little apart from oil, and exports practically everything. So how does that hit it?
I think what is effectively happening is that China is importing inflation. The inflation that should’ve actually occurred in the US and similar places gets deferred due to cheap chinese goods, and due to the skewed exchange rates, hits in China. I’ve read a couple of reports that inflation is starting to pinch China, and that they are resorting to price controls over there. Sooner rather than later, that might force them ot revalue the RMB, restoring the world order, and adding inflation to the downturn in the US economy.
2. I had got convinced by one article by Ajay Shah in the business standard, and was happy that the RBI had allowed the rupee to appreciate in order to control inflation back home. Now, I read somewhere that since India’s current account is in deficit, the rupee shouldnt’ be allowed to appreciate. That the current account alone should determine exchange rates, and not the capital account – which is in a way reversible flow. I’m wondering if there’s any good way in which we sterilize all the capital account imbalance, hoping that one day when this mad influx of capital ends, it’ll all even out.
So what do we do to take care of this situation? For starters, we need to have effective ways of reducing incoming capital. The control measures we have are half-baked (limiting borrowings, participatory notes, etc.). Maybe I should allow myself to get swayed by Ajay Shah again, and say that we need to cut rates. Even if we account for a fair price of oil, I don’t think inflation is too much, so we could afford to cut rates. And that will in some way balance flows.
3. A V Rajwade, in his article in the business standard last monday, argued that another major source of short term capital inflow is in terms of credit given to importers! Interesting stuff
I know I’ve rambled for most parts. Still fairly confused about this. Anyways let me know your views on this.?