Wednesday, March 31, 2010

Clamour for China peg - Need or Greed??

Whenever there is a sustained rupee appreciation against dollar, exporters would quickly join together and clamour for govt intervention and lobby for currency peg as in case of China. Before countering or acceding to their claim, it is necessary to analyse whether such a peg is feasible and if yes, whether such a peg is essential in Indian conditions. It would be educative to find out why the currency peg is being adopted in China.

It is in fact true that a volatile currency will adversely impact the businesses that buy from/sell to foreign entrepreneurs. But the onus is on part of entrepreneurs to evolve mechanisms to mitigate their exposures through derivative instruments and not to lobby the government to intervene and peg the currency. The recent introduction of exchange traded currency derivative products by RBI is a right step in assisting the exporters to hedge their positions against currency volatilities. It is time for entrepreneurs to evolve rather than relying on spoon feed from the government.

China is able to implement and continue with its currency peg withstanding foreign pressure because of its authoritarian governance structure and powerful economic clout. India, with its weak resource base and democratic set-up will find it difficult, first to implement currency peg and then to sustain it. It is also not desirable, not to allow currency appreciation, in a chronic trade deficit country like India where currency appreciation, which narrows the deficit in real terms, should in fact be actively encouraged. It is also curious to know that calls for currency depreciation is louder from industries with significant lobbying power like Software companies rather than textile and leather industries.

Hence, it makes more sense for the government to actively encourage exporters and importers to use hedging mechanisms to mitigate loss rather than getting back to regulated regime of 80s. Having moved to a market economy, short-term currency fluctuations should be accepted by entrepreneurs as part of business.

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