Rajeswari Sengupta

Impact of Exchange Rate Movements on Exports: An Analysis of Indian Non-Financial Sector Firms

We explore the real effective exchange rate (REER) effects on the share of exports of Indian non-financial sector firms for the period 2000 to 2010. Our empirical analysis reveals that, on average, there has been a strong and significant negative impact of currency appreciation as well as currency volatility on Indian firms’ export shares. While the firm-level accounting information and other macro variables have limited implications, there is evidence that these Indian firms respond asymmetrically to exchange rates. For instance, the REER change effect is likely to be driven by a negative appreciation effect but not so much a depreciation effect. Also, the Indian firms that have smaller export shares tend to have a stronger response to both REER change and volatility. Compared with those exporting goods, the firms that export services are more affected by exchange rate fluctuations. The findings, especially those on asymmetric responses, have important policy implications.

India’s Trilemma: Financial Liberalisation, Exchange Rates and Monetary Policy

A key challenge for macroeconomic policy in open economies is how to simultaneously manage exchange rates, interest rates and capital account openness – the trilemma. This study calculates a trilemma index for India and investigates its evolution over time. We find that financial integration has increased markedly after the mid‐2000s, with corresponding limitations on monetary independence (MI) and exchange rate stability (ES). In addition, we empirically confirm that a rise in one trilemma variable is traded off with a drop in the weighted sum of the other two, i.e. the trilemma configuration is binding in India. Finally, we consider the implications of changes in the trilemma index for macroeconomic outcomes. We find that greater MI systemically contributes to lower inflation, so the twin goals of ES and capital account openness may create policy dilemmas in particular economic environments. ES is associated with less inflation volatility, suggesting that there may be secondary benefits channelled through import and commodity prices. In these relationships, however, changes in international reserves are not statistically significant, suggesting that foreign exchange market intervention has not mitigated the trilemma trade‐off in India.

The financial trilemma in China and a comparative analysis with India

A key challenge facing most emerging market economies today is how to simultaneously maintain monetary independence, exchange rate stability and financial integration subject to the constraints imposed by the Trilemma, in an era of widespread globalization. In this paper we overview and contrast the Trilemma policy choices and tradeoffs faced by the two key drivers of global economic growth-China and India. China’s Trilemma configurations are unique relative to other emerging markets in the predominance of exchange rate stability, and in the failure of the Trilemma regression to capture a consistently significant role for financial integration. In contrast, the Trilemma configurations of India are in line with choices made by other emerging countries. India like other emerging economies has overtime converged towards a middle ground between the three policy objectives, and has achieved comparable levels of exchange rate stability and financial integration buffered by sizeable international reserves.

Financial Trilemma in China and a Comparative Analysis with India

A key challenge facing most emerging market economies today is how to simultaneously maintain monetary independence, exchange rate stability and financial integration subject to the constraints imposed by the Trilemma, in the era of deepening globalization. In this paper we study the Trilemma choices of the two key drivers of global growth, China and India. We overview and contrast the policy choices of the two, and test their Trilemma choices and tradeoffs. China’s Trilemma configurations are unique relative to the one characterizing other emerging markets in the predominance of exchange rate stability, and in the failure of the Trilemma regression to capture any significant role for financial integration. One possible interpretation is that the segmentation of the domestic capital market in China, its array of capital controls and the large hoarding of international reserves imply that the “policy interest rate” does not reflect the stance of monetary policy. In contrast, the Trilemma configurations of India are in line with the regression results of other emerging countries, and are consistent with the predictions of the Trilemma tradeoffs. India like other emerging economies has overtime converged towards a middle ground between the three policy objectives, and has achieved comparable levels of exchange rate stability and financial integration buffered by sizeable international reserves. (This abstract was borrowed from another version of this item.)

Is India Ready for Inflation Targeting

Abstract In this paper we analyze the extent to which the current macroeconomic environment in India is suitable for implementation of inflation targeting as a monetary policy strategy, in light of the recommendation of the Urjit Patel Committee Report. Our results indicate that historically the Reserve Bank of India has given more importance to inflation compared to output growth and exchange rate changes in its monetary policy conduct and that in recent times there has been an increased emphasis on monetary independence thereby comfortably placing the RBI on a path to move towards inflation targeting. However we also find factors, that are traditionally outside the control of monetary policy, do exert a strong impact on aggregate prices in India thereby making the choice of nominal anchor a tricky one. Furthermore, the success of monetary policy in containing inflation is found to be crucially contingent on an appropriate fiscal policy as well.

Monetary Transmission in Developing Countries: Evidence from India

There are strong priori reasons to believe that monetary transmission may be weaker and less reliable in low- than in high-income countries. This is as true in India as it is elsewhere. While its floating exchange rate gives the RBI monetary autonomy, the country’s limited degree of integration with world financial markets and RBI’s interventions in the foreign exchange markets limit the strength of the exchange rate channel of monetary transmission. The country lacks large and liquid secondary markets for debt instruments, as well as a well-functioning stock market. This means that monetary policy effects on aggregate demand would tend to operate primarily through the bank lending channel. Yet the formal banking sector is small, and does not intermediate for a large share of the economy. Moreover, there is evidence that not only are the costs of financial intermediation high but also that the banking system may not be very competitive. The presence of all these factors should tend to weaken the process of monetary transmission in India. This paper examines what the empirical evidence has to say about the strength of monetary transmission in India, using the structural vector autoregression (SVAR) methods that have been applied broadly to investigate this issue in many countries, including high-, middle-, and low-income ones. We estimate a monthly VAR with data from April 2001 to December 2014. Applying a variety of methods to identify exogenous movements in the policy rate in the data, we find consistently that positive shocks to the policy rate result in statistically significant effects (at least at confidence levels typically used in such applications) on the bank lending rate in the direction predicted by theory. Specifically, a tightening of monetary policy is associated with an increase in bank lending rates, consistent with evidence for the first stage of transmission in the bank lending channel. While pass-through from the policy rate to bank lending rates is in the right (theoretically expected) direction, the pass-through is incomplete. When the monetary policy variable is ordered first, effects on the real effective exchange rate are also in the theoretically expected direction on impact, but are extremely weak and not statistically significant, even at the 90 % confidence level, for any of the four monetary policy variants that we investigate. Finally, we are unable to uncover evidence for any effect of monetary policy shocks on aggregate demand, as recorded either in the industrial production (IIP) gap or the inflation rate. None of these effects are estimated with strong precision, which may reflect either instability in monetary transmission or the limitations of the empirical methodology. Overall, the empirical tests yield a mixed message on the effectiveness of monetary policy in India, but perhaps one that is more favorable than is typical of many countries at similar income levels.

Policy Tradeoffs in an Open Economy and the Role of G-20 in Global Macroeconomic Policy Coordination

In this paper we investigate the different nuances of India’s capital account management through empirical analyses as well as descriptive discussions. In particular we study the evolution of the capital control regime in India since 1991, and explore the rationale behind liberalizing certain flows, restricting others and the means employed to do so. Increased integration with global financial markets has amplified the complexity of macroeconomic management in India. We analyze the trade-offs faced by Indian policy makers between exchange rate stability, monetary autnomy and capital account opnenness, within the framework of the well-known Impossible Trinity or Trilemma and find that over time India has adopted an intermediate regime balancing the different policy objectives while at the same time accumulating massive international reserves. We also calculate the exchange market pressure (EMP) index in India, and track its evolution over the last couple of decades. We evaluate the extent to which the EMP index has been influenced by major macroeconomic factors and find that a deteriorating trade balance and decline in portfolio equity inflows are associated with a higher EMP while positive changes in stock market returns lower the EMP.

The Impossible Trinity: Where Does India Stand?

The Global Financial Crisis of 2008 and the heightened macroeconomic and financial volatility that followed the crisis raised important questions about the current international financial architecture as well as about individual countries’ external macroeconomic policies. Policy- makers dealing with the global crisis have been confronted with the ‘impossible trinity’ or the ‘Trilemma’, a potent paradigm of open economy macroeconomics asserting that a country may not target the exchange rate, conduct an independent monetary policy and have full financial integration, all at the same time. This issue is highly pertinent for India. A number of challenges have emanated from India’s greater integration with the global financial markets during the last two decades, one of which includes managing the policy tradeoffs under the Trilemma. In this chapter, I present a comprehensive overview of a few empirical studies that have explored the issue of Trilemma in the Indian context. Based on these studies I attempt to analyze how have Indian policy makers dealt with the various trade-offs while managing the Trilemma over the last two decades.