Academic journal article Journal of Economics and Economic Education Research

Explaining Why Indian Trade Balance Didn't Improve with Its Currency Devaluation

Academic journal article Journal of Economics and Economic Education Research

Explaining Why Indian Trade Balance Didn't Improve with Its Currency Devaluation

Article excerpt

INTRODUCTION

The global financial crisis of 2007-09 initiated a round of international monetary system reform. For instance, European Central Bank has been actively engaged in reforming its monetary policy in the face of extended downfall of economic activity that had left some member economies in dismay. China, one of the fastest growing emerging economies, expedited its currency, RMB, appreciation process and even started to internationalize RMB. Another potential leader in global economic growth, India, on the other hand, seems to rely on free exchange rate regime as part of its monetary policy. With China and India being two of the high growth rate economies implementing contrasting monetary policies, the former has witnessed much better economic results as compared to the latter.

In exchange markets, INR, has depreciated drastically since the beginning of global economic downturn. In January 2008, USD-INR exchange rate was approximately 39 and six years later it was almost 62. A sharp devaluation of currency should have had stimulating effects on its economy through expected higher exports and higher capital inflow in the short run, or at least have helped India take some shares of China's exports in the global market. However, contrary to expectations none of this happened and India has a growing negative trade balance that dampens the growth in GDP. These outcomes challenge the basic assumptions of free exchange rate models and its impact on trade balances. In this research we analyze Indian monetary policy in relation to its' international trade, and the mix of the top trade categories of goods and services alongside India's major trading partners to offer a viable rationale for this situation.

REVIEW OF THE LITERATURE

The Indian economy has exhibited promise to be one of the major power-houses of the world economic output. According to the World Development Indicators database, currently Indian Gross Domestic Product (GDP) is tenth largest in the world in nominal value and the third largest in Purchasing Power Parity. India had a real annual GDP growth rate of 6.7 percent in the last two decades and more than 7.5 percent in the last decade which is surpassed only by China among the "BRIC" nations (Brazil, Russia, India, China, an acronym for the four of the fastest developing economies in the world). The Indian economy is becoming more and more de-centralized in the last two decades following its openness to world trade (Krueger, 2002). The increasing foreign trade brought a much needed capital injection from foreign investors to non-farm private sector, making a major force in a traditionally agricultural economy (Iversen et al., 2014).

Comparing the Indian economy to that of the Chinese, one cannot overlook the differing monetary policies of these two global growth engines (Bosworth and Collins, 2008). China has strongly implemented strict controls over its currency RMB exchange value in relation to United States dollar (USD) in the foreign exchange (FX) markets. By doing so, China has been able to provide competitive pricing edge to its export industry in world trade (Cheung, 2012). Chinese monetary policy has been effective in controlling its currency value volatility to the minimum. In contrast, Indian monetary policy has not been effective in keeping its currency value from fluctuating drastically. Despite constant inflation in India, the rupee has witnessed some episodes of increases in nominal value which coupled with domestic high inflation creates an unconducive trade environment for its exports industry.

However, the Chinese policy of maintaining its currency exchange value to a given level has its own downside. The economy must either restrict capital flow to and from the economy thus also restricting many prospective projects by foreigners in domestic economy and vice versa --or give up its control of internal monetary policy to keep the exchange value from fluctuating (Song et al. …

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