There is a new-found spring in the Indian step – foreign exchange reserves are burgeoning, debt is being paid back, and the otherwise depreciating rupee is appreciating. In the eyes of some, stardom will be achieved when the rupee exchanges with the US dollar at a macho rate of Rs 38 (it is currently trading at Rs. 46.7). In the eyes of most others, it is occasion to feel proud – we are achieving a higher growth rate than most of the rest of the world, and therefore should indulge by celebrating the rising rise of the Rupee (and therefore killing the golden goose). Even the dormant leftists have joined in the clamor for “justice” – the dollar should be beaten down because of naughty American imperialism.

We also celebrated with our pride in the fifties and sixties when we insisted on growing our own steel, on building with our bare hands our own machines, and keeping our exchange rate at a high level to support our pride in our own model of development. Not for us the cheap attitudes of the Japanese who were selling "cheap" goods at an even cheaper exchange rate. Ditto the case of Korea. But we were better because we did not rely entirely on American support for our existence as a nation. Why should we sell our goods cheap to the imperialists? In the seventies, Indonesia started to grow at rates higher than our own "pride peak" growth rates of the last two decades. But Indonesia was corrupt, did not have democracy and worse, was emphasizing exports through a subsidized exchange rate. Selling the labor so cheap - why, they were becoming the sweatbox for the rich. Didn't they have pride in their labor; didn't they feel shameful in exploiting their poor labor for the whims of the white, imperialist world?

By now, the East Asian model of undervaluing the currency - yes making it cheap for the rich consumers - was causing a lot of Asians to escape poverty, and become middle class, if not rich. The gang of a few had become the gang of many: Japan, Korea, Taiwan, Hong Kong, Singapore, Indonesia, Malaysia, and Thailand all joined the rat race for ever cheaper exchange rates, and goods. Their population was about two-thirds that of India, so while they did not have individual might, their collective influence in the economic world was growing, and was vastly superior, than that of India.

In the eighties, the most mercantilist of the East Asians, China, joined the capitalist world. With advice, support, and encouragement from the international institutions, and Western governments, China moved towards cornering several chunks of the world market - toys, electronic goods, textiles, furniture, etc. You name it - and it was made in China. Why were the Chinese able to do it? By making their labor and currency cheap - pride came from catching mice, not from coffee-house ideology or macho priced exchange rates.

Not only China, but the world started to change in the eighties - as it became more integrated, competition became more intense. No producer could afford to now "pass- thru" her costs. When Britain had the Black-Wednesday devaluation in 1992, most pundits argued that inflation would follow as imports became more expensive. What happened - inflation declined, and growth rates increased. When Mexico devalued in Dec 1994, the same economic pundits argued for a large increase in inflation and a decline in growth (remember the output-inflation tradeoff?). What happened - inflation declined and growth galloped. Ditto with the even larger devaluation East Asian crisis in 1997 - inflation declined and growth, after a very brief interlude, rebounded. Why were (are) the pundits so wrong? Because they don't appreciate that in a globalized integrated world, as long as there are 1.3 billion Chinese, and 1 billion Indians, you cannot have inflation. There are too many producers, too many individuals at all skill levels - especially in formerly poor, but now more educated, countries. The unlimited supplies of labor from these countries keep a lid on international wages - for all skilled levels. It is now beat the Chinese and the Indian in terms of international productivity per unit cost of domestically priced labor. (Capital cost differences are mattering less and less, thanks to de facto capital account convertibility in many countries). Market share is the new mantra, and the profits come later - they always do.

In a recent paper (Trade, Growth and Poverty - Re-examining the Linkages, presented at a World Bank-Asian Development Bank conference in Oct. 2002) I attempted to document the growth effect of undervaluation of exchange rates i.e. what was the increase in potential (and actual) growth rates for each 10 percent decline in the real exchange rate, ceteris paribus? The answer - a robust 1 percent extra GDP growth.

The attached table lists the changes equilibrium exchange rates (equilibrium defined both conventionally as that occurring through the difference in inflation rates, and according to a productivity adjusted model), for selected countries in the last four years (since May 1999). (While level magnitudes are subject to the choice of a base year, the change in valuation magnitudes are not conditional on such a choice).

As most Indian producers know (and their counterparts all over the non-Chinese world), the mercantilist Chinese engine, became even more surplus oriented! Even by the conventional measure of undervaluation (adjustment only by relative inflation), it gained in competitiveness by 8.4 percent; productivity adjusted competitiveness increased by a much larger 20.6 percent! The "fair" exchange rate for the Chinese yuan is 5.82; it presently trades at a "fixed" exchange rate of 8.28. Contrast this performance with that of the Indian rupee - it's competitiveness worsened by 1.3 percent since May 1999 (non- productivity adjusted, India's competitiveness improved marginally by 3 percent). So relative to the Chinese, we have lost competitiveness by a huge 22 percent.

The undervaluation model can be used for understanding the "thinking" in each country - and such thinking can be further tested by forecasts. Watch out for changes happening in Latin America as it finally begins to get its act together. Chile has added 15 percent to its competitiveness (i.e. Chilean exports are 15 percent cheaper than they were in May 1999), Brazil has added 22 percent and Argentina 45 percent. The growth rates in these economies should accelerate by approximately 1.5, 2.2 and 4.5 percent respectively. Clearly, the leftist Lula knows where his political fortunes lie, along with the economic fortunes of his country - with under-valuation, or a gain in competitiveness.

The calculations presented are suggestive, but overwhelmingly point to the simple reality that India's exchange rate policy has not been competitive enhancing, though it might have done wonders for macho-muscle (M2) building. We have lost out to most of our competitors, and this will clearly dampen attempts to attain 7 percent growth, let alone 8 plus and beyond. And while other countries laugh their way to the bank with bulging exports, Indians will be left with the perennial question - why are we always behind the curve in our thinking? With an ever-rising rupee, why don't we reduce interest rates? Is it the Hindu attempt to be unique, or do we claim that high real interest rates, and an over- valued exchange rate, is the cost we must pay for having the world's largest democracy?