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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!
Ratio of Trade Deflators to GDP deflator (Px+ PM)/2)/PGDP
1.20
1.00
0.80
0.60
0.40
0.20
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Series1
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 nontradables.
Explanation?
 Also three small points.


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Productivity differential dismissed but here
tradable services sector is counted as nontradable. 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.