Comments: What Explains India’s Real Appreciation? by Robert Z Lawrence Comments on Kholi and Mohapatra India Policy Forum Delhi July 2008

Why Worry About the Real Exchange Rate? An Important Topic for price-taking economies. (a) Macro-Policy : If real appreciation is required either permanently higher inflation or appreciating exchange rates & price stability. (b) Competitiveness. In price-taking economy ratio of non-traded to traded goods prices plays key role

Major Findings. Real Exchange Rate has appreciated Productivity differentials explain little. Instead demand is important (a) Government spending. (b) Increased services spending (higher income growth) And some role for declining import prices.

Policy Implications Exchange Rate Flexibility. More Fiscal Discipline. Continue trade and other reforms.

My Points (a) Measurement problems. (b) Interpretation of the Evidence. © Policy implications.

Measurement Issues. Choice of Prices. Exportability not Tradability! Follows literature but why no attention to imports! Imports relevant for inflation concerns. Imports relevant for adjustment Omission of agriculture as tradable

Has the real exchange rate appreciated? Not on this basis!

Real Effective Rate: Constant After 1993!

India is not exceptional Implications: If Real Effective Exchange Rate is constant and Real Internal Exchange Rate Appreciates – The rise is the same in India as in the Rest of the World. So nothing really exceptional

Explanation Labor productivity plays very small part. Explanation offered econometrically is basically in terms of demand growth. Government spending and services demand Falling import prices also play a role.

Puzzle How to explain stronger real exchange rate and increased share of tradable output? Improvements in transportation, information and telecommunications increases ability to supply tradables without raising their prices Also could be constraints on supply of non-tradables.

Explanation? Also three small points. Productivity differential dismissed but here tradable services sector is counted as non-tradable. Biased against this explanation. Import reforms improperly measured by import unit values: “Higher per capita incomes” not same as increasing share of services.

Policy Implications Floating Exchange Rates: Yes but could simply accommodate with higher inflation. Tighter fiscal policy? Empirical evidence was not about deficits but rather about spending What’s wrong if it reflects public preferences nothing wrong with higher prices – still could be a role for supply-side policies too Is competitiveness threatened? Motive for paper but never really explored.

Conclusions Not clear to me that the exchange rate has really appreciated or is significantly impeding Indian competitiveness Need more work to get a better handle on productivity growth. Need more work to integrate the supply side empirically. The role of import policy could be captured better.