India’s policy of rupee appreciation has had the unfortunate, and predictable, effects of not only hurting the Indian economy but also benefitting the Chinese economy.

A favorite conversation point in cocktail circuits (but after the French president and the US elections) is the value of the rupee. Passions run high, as do explanations and forecasts. But all assessments reveal the pocketbook. In one camp are those who have profited handsomely - foreign investment banks, domestic firms who had the good fortune to borrow in dollars made cheaper by the rupee rise, and economists who believe that there are large gains to the economy with a rise of the rupee. In the losers camp are not only large job losses in the export industries, but also a general slowdown of the Indian economy. All this before the slowdown in the developed world begins to hurt Indian growth.

There is no question that the decision to advance the rupee by a whopping 9 percent in one month (mid March- mid April 2007) was made at the highest levels of government - the Congress party, the PM, Finance Minister and RBI Governor must have been involved. The policy parlour game is about who was the real "culprit". The finger of suspicion generally points to the Congress party and the FM - the belief is that the Congress was so upset about losing elections, that they started looking for excuses beyond their own incompetence and settled on: inflation. Crude calculations were made about the likely impact of the rupee appreciation on inflation. Answer, a lot, just look at the oil bill and the rising share of trade in the Indian economy. At 25 % share of trade in GDP, a 13 % appreciation of the rupee would lead to a more than 3 percentage point decline in the inflation rate. Let's do it was the Congress war cry.

There were others for whom a rupee appreciation was "desirable". These were those who, (as it turns out was the case ex-ante and ex-post), wrongly suggested that the Indian economy was in "overheated" mode. Distinguished policy makers were in this club, mostly populated by ex and present members of the RBI. This confluence of interests must have been too much for those who resisted rupee appreciation in the government; hence, the government consensus decision to significantly appreciate the rupee in March 2007.

Almost a year has passed; time for a serious evaluation. Did the policy succeed in reducing the inflation rate? Of course it did, say the protagonists. Inflation is today at around 3 percent, a decline from the 6 % rate observed before the rupee rise. Nonsense and not true say others; as pointed out in early March (Bhalla, Surjit: Inflation - An Ex-Problem?, Business Standard, March 3rd, 2007), the seasonally adjusted six month inflation rate in February 2007 was already down to 3 percent! So, exchange rate policy has had a zero effect on inflation; as expected, since it is unclear how exchange rate policy can affect inflation caused by supply side shortages of food!

Having lost this important rationale, the defenders of rupee rise have introduced a new twist: "Asia has to play its role in correcting global imbalances and therefore India has to appreciate its currency along with China, Korea, Malaysia, Singapore etc". Why that has to be so is unclear, especially given the fact that most of our East Asian neighbors have current account surpluses (CAS) while India has a current account deficit of around 3 % of GDP. China has a CAS of 13 percent of GDP, the largest ever recorded by a non-oil exporter. So, based on fundamentals, China, Malaysia, Singapore etc. should let their currencies appreciate, and India should engineer a rupee depreciation.

The table documents the trend in the real exchange rate (the one that matters for competiveness, and jobs, and economic growth). Two real exchange rates are reported; the first is the rate with just the US dollar, and the second is a trade-weighted exchange rate (IMF for China and RBI for India). According to the bilateral real rate, India has lost about 10 % in competitiveness to super-competitive large trade surplus China. This holds regardless of the starting date - 2000, or 2004, or 2005 or 2006.

The IMF real trade-weighted exchange rate for China shows a depreciation of 1 percent since 2000, in contrast to a 5.5 % appreciation for India. Since 2005 the Chinese yuan has a marginally higher appreciation rate, and the reverse is true for India if the starting year is 2006. Prior to 2007, India had the same real trade-weighted exchange rate in 2006 as in 2000; China's RER was 5 % lower. (These numbers compare the value for 2007 relative to earlier years). This gives some indication of the under-valuation of the Chinese yuan. Comparing today (mid-Jan. 2008) to 2000, India shows a 9 % appreciation, China shows a 1 percent appreciation. Thus, regardless of pyrotechnics involved with "dating" the appreciation episodes, the fact remains that India has lost competitiveness with respect to China.

In this globalized, integrated, razor-thin competitive world, exchange rate policy matters, and our policy makers should realize that they cannot take arm-chair explanations of politicians and journalists (yes, and even economists) as indicative of what matters in the real world. Our hasty, ill-thought out exchange rate policy has given a major advantage to our competitors, especially China. It is commonly believed that the only beneficiary of the Left's opposition to India's nuclear policy is our political competitors, Pakistan and China. Equivalently, the major beneficiary to our exchange rate policy is our economic competitor, China. Perhaps inadvertently, the Congress (and the RBI?) has done the same damage to economic India as the Left is keen to inflict on political India.