Need Tally
for Clients?

Contact Us! Here

  Tally Auditor

License (Renewal)
  Tally Gold

License Renewal

  Tally Silver

License Renewal
  Tally Silver

New Licence
  Tally Gold

New Licence
 
Open DEMAT Account with in 24 Hrs and start investing now!
« Top Headlines »
Open DEMAT Account in 24 hrs
 March 31 deadline is getting near. How to save income tax with tax loss harvesting?
 45-day MSME payment rule: Impact and details of Section 43B(h) explained
 Small savings schemes that offer tax benefits of up to Rs 1.5 lakh under section 80C
 RE-OPENING OF CORRECTION WINDOW FOR MAY 2024 CA EXAMINATIONS
 Powerful Upgrades, Tally 12+1 months renewal Plan and Connected Services for your growing Business - March 2024
 How innovative solutions can help fix the Sec 43B conundrum for MSMEs
 Income Tax dept asks many individuals to explain high value transactions of FY20-21 as Updated ITR deadline nears
 Release Notes for TallyPrime and TallyPrime Edit Log Release 4.1 | What s New!
 Deadline to file updated ITR FY20-21 ends on March 31: Details on additional tax
 4 tax-planning mistakes to avoid this season
 ITR 2024: Here are 8 ways by which senior citizens can save on taxes this year

Budget and currency stability
February, 24th 2007
Apt fiscal policies and certainty about fiscal soundness have a big impact on the rupee's strength and stability. Currency instability is set off when the growth rate and purchasing power rise become uncertain. The Budget will thus have to be designed such that these factors become certain. They cannot be accidental or coincidental, says G. RAMACHANDRAN.

Budgets and the economy's boilerplate issues are normally analysed together. The relationship between fiscal causes and economic effects is like gravity itself. This explains why the Economic Survey is published a day or so before the Budget is presented. Currency stability and the relative value of the rupee are economic effects of fiscal causes that are set to become boilerplate issues from 2007.

Currency strength and stability will join six evergreen issues: taxes, duties, deficits, growth, interest rates and inflation. The two are the new issues that will have to be intensely analysed. They will have to be watched with eagle eyes. This year's Budget provides the start. Currency stability and strength were for long regarded as results of activities on Mint Street and Print Street in Mumbai. The fact is New Delhi's Sprint Street where India's growth mangers work and Dint Street where India's economic expectations are shaped determine the strength and stability of the rupee.

Four stable systems

An economy has the choice of being in any one of six exchange rate systems. No one forces this choice. This choice is driven from within each economy. Leaders choose exchange rate systems on how they the exchange rate systems impact the other systems that define society and the economy. The choice is reversible.

The means to achieve currency stability is a principal determinant of this choice. The first two of the six systems `dollarisation' and `currency board' provide comprehensive stability. They account for 26 per cent of the world's currency systems. Examples follow. Ecuador, El Salvador and Panama use the American dollar as their currency. Hong Kong's currency board establishes and maintains parity with the US dollar. The currency boards of Estonia and Bulgaria establish and maintain parity with the euro.

The third and the fourth systems pegged and crawling pegged provide decreasing control over currency stability. Pegged currencies are far more stable than crawling currencies. They account for 25 per cent of the world's currency systems. Parity value is established by the central bank relative to another currency or basket of currencies. Then the central bank conducts monetary policy to maintain this parity. The Chinese yuan is the world's most famous pegged currency, pegged to a basket of currencies. The basket provides some degree of flexibility against individual currencies.

Crawling pegged currencies account for 5 per cent of the world's currency systems. They are less stable than pegged currencies. Bolivia, Costa Rica and Nicaragua have crawling pegs. Their parity values are set by their central banks. They are changed when necessary. The crawl is typically designed to compensate for differences between the economic performance of the pegged and peg economies.

Instability by design

Fifty-six per cent of the world's currencies are stable because their central banks manage the currencies. The rupee is not one of these. Economies that have adopted dollarisation, currency board, pegged and crawling pegged charge their central banks with the responsibility of setting the strength and then maintaining stability. Currency instability is alien to these economies. Moreover, they do not trust the currency markets to set the parity.

The fifth and the sixth currency systems managed float and full float each account for 22 per cent of the world's currencies. Currencies in managed float are more stable than those in full float. The Indian rupee is the world's most famous managed float currency. The US dollar and the British pound are in full float. Currency stability is an issue that these floating systems have to reckon with. Their central banks are not charged with the responsibility of setting the strength. The currency markets set the strength. But maintaining stability is a concern to all.

Degrees of freedom

So, currency stability is the result of a major policy choice. It would be apt to wonder why an economy would be so foolish as to choose currency instability when it can choose more control and more stability. Are the UK, India and the US foolish, while China, Hong Kong, Bulgaria, Ecuador and Estonia are smart? No, it would be wrong to believe so.

Floating systems generate more degrees of freedom for the conduct of economic policy. They make monetary policy autonomous. They shift control over monetary policy to the central bank. The economy's leaders trust the central bank's competence in managing interest rates and price stability.

But they also shift control over currency strength and stability to the currency markets. The economy's leaders trust the maturity and self-interest of the currency markets in the context of setting the value of the domestic currency dynamically against other currencies.

Therefore, currency parity and currency stability are not the responsibilities of the Reserve Bank of India (RBI). And, this is where the role of the Finance Ministry becomes very critical. Apt fiscal policies, and certainty about fiscal fidelity and soundness have a very profound impact on the rupee's strength and stability.

Clear responsibility

To understand how the Finance Ministry and fiscal policy can lead to currency stability, we need to examine the factors that affect the market value of the rupee. These factors are under the full control of the government and the Finance Ministry. Any instability of these factors will lead to the instability of the rupee.

Relative inflation rates, relative interest rates, relative income and purchasing power levels, relative productivity levels and expectations drive the value and the stability of the rupee. The first three factors work with similar effect. The last two work with similar effect.

First, if India's expected inflation is higher than that of, say, the US, the rupee will weaken relative to the dollar. Second, if interest rates in India are higher than that in the US, the rupee will be at a forward discount vis--vis the dollar. The first two factors place a significant burden on the Budget. It has to be so designed as to suppress all possible sources of price instability. It has to be so designed as to keep government's demand for short-term credit and long-term borrowings transparent.

The third factor is growth and purchasing power. If India's economic growth rate and purchasing power are higher relative to those of, say, the US, the rupee will weaken relative to the dollar. Higher growth and purchasing power lead to imports of both capital assets and consumables. The rupee will have to weaken. But that by itself will not lead to currency instability. Currency instability will be set off when the growth rate and purchasing power rise become uncertain. So, the Budget will have to be designed in such a manner that the growth rate and purchasing power increase become certain. In short, the Budget will have to have growth and purchasing power as known objectives. They cannot be accidental or coincidental.

Productivity gains

The fourth factor is productivity. If India's productivity rise is higher relative to that of, say, the US, the rupee will strengthen relative to the dollar. Higher productivity will lead to increased exports and bigger foreign direct investment. Currency instability will follow when the market is unsure about productivity gains. The Budget will have to make productivity growth a known objective. The fifth factor is expectations. If India's popular expectations of growth and prosperity are more stable relative to that of, say, the US, the rupee will strengthen relative to the dollar. The rupee will also be more stable.

This is the most significant and onerous issue that the Budget will have to address. It will have to sustain popular expectations of jobs, incomes, growth and prosperity. What this means is that the Budget will have to carry on from where it left off in 2006.

G. RAMACHANDRAN
(The author is a financial analyst.)

Home | About Us | Terms and Conditions | Contact Us
Copyright 2024 CAinINDIA All Right Reserved.
Designed and Developed by Ritz Consulting