A quiet revolution is unfolding in India and it could say much about the future of Asia’s fast-growing economies.
In New Delhi, finance minister Palaniappan Chidambaram is standing by as the rupee rises. It has gained almost 10% versus the US dollar over the past 12 months, and 18% against the yen. To say that hasn’t gone over well with India’s business establishment would be a gross understatement.
Take Munish Saigal, director of foreign exchange at Ranbaxy Laboratories Ltd, India’s largest drug maker. He says the rupee’s advance to a nine-year high against the dollar is “madness” and won’t last. “The rupee is massively overvalued and there needs to be some sanity to find out what the appropriate level is,” Saigal said last month. Also last month, Ganesh K. Gupta, president of the Federation of Indian Export Organizations, in Mumbai, said the rupee’s appreciation “is a disaster for the export community”.
Chidambaram seems to think otherwise, and India’s 1.1 billion people will be better off in the long run for it. Ditto for the rest of Asia, if it were to follow India’s lead.
Earlier in the year, Indian officials seemed to try their hand at halting the rupee’s ascent. In January and February, traders buzzed about government efforts to sell the currency.
The finance minister no longer seems to be fighting the tide. Indian officials may realize that pumping up economic growth with a weak currency is counter productive. It takes pressure off politicians to modernize economies and reduces the urgency for entrepreneurship in the private sector. It increases the risk of importing inflation amid high commodity prices. Weak currency policies give investors fewer incentives to move capital your way. Also, amassing hundreds of billions of dollars of US Treasuries is an unproductive use of savings. That money could be put to better use building roads and power systems and paying for education and health care at home.
One of the best reminders of the futility of obsessing over currencies came from Paul O’Neill in December 2002, when he was US President George W. Bush’s Treasury secretary. O’Neill, a former Alcoa Inc. chairman, said good chief executives “don’t live and die on exchange rates”. In other words, companies bellyaching about currencies are just looking for state help.
It’s not easy for executives in a developing nation to compete globally with US, European and Japanese peers. Yet, relying less on a weak currency could raise India’s corporate game to new heights. A key reason China lacks India’s entrepreneurial spirit is that Chinese companies are, thanks to a weak yuan, focused on exporting goods cheaply—not innovating and creating new ones.
Is India’s currency tolerance spreading in Asia—especially to North Asia? Well, certainly not to China or Japan, both of which work hard to keep their currencies weak. Yet, there are glimmers of hope in South Korea.
South Korean finance minister Kwon Okyu seems to be engaged in his own experiment of sorts with a stronger currency. The won isn’t appreciating much versus the US dollar. It has gained just 0.9% over the past 12 months. Against the Japanese yen, though, the won has risen almost 9%.
Kwon’s tolerance for a stronger won has great significance to economists such as Nouriel Roubini, chairman of New York-based Roubini Global Economics LLC. “Korea is an important example of a nation trying to get off the Bretton Woods II system,” Roubini had said on 4 May at the Asian Development Bank’s (ADB) annual meeting in Kyoto.
In Kyoto, Roubini told me more about his concerns that Asia is setting the stage for another financial crisis, more of its own making than the last one.
“When you look back at this period years from now, we will say Asia learned the wrong lessons from 1997 and created another currency crisis,” he said.
The reference here is to the Bretton Woods II system that has emerged since 1997. After the Bretton Woods regime of pegging currencies to gold collapsed in 1971, many nations just pegged to the US dollar. By the late 1990s, much of Asia couldn’t maintain that arrangement and currencies plunged.
What followed was recognition of the wisdom of flexible exchange rates. As the 2000s began, though, governments under pressure to boost growth opted to help exporters with weak currencies. And many will argue the ends have justified the means. Asia, excluding Japan, will grow 7.6% in 2007, and 7.7% next year, ADB said.
It’s hardly madness
Today’s growth may come at a cost in the long run. “This new model is leading to excessive monetary and credit growth, asset bubbles in stock markets, housing markets and other financial markets that will eventually lead to a build-up of financial vulnerabilities,” Roubini said. “That could trigger a financial crisis different from that of 1997, but that could be potentially as severe,” he said. That’s why Korea’s flirting with a stronger won may be an important harbinger of sobriety in North Asia. The real test will be whether the country allows the won to surge versus the dollar.
In the age of globalization, a strong currency is ultimately a sign of confidence in an economy’s prospects. Let’s hope India stays the course, and others in Asia follow its lead. That would be anything, but madness.