Ajay Shah pointed to this intriguing speech from Glenn Stevens, Governor, Reserve Bank of Australia. The speech is about how Australia went about reforming its monetary policy and more importantly the way it managed the surging capital flows in the country.
Australia too has struggled on occasion with capital flows and their complicating role for the conduct of monetary policy. But Australia’s biggest problems for the conduct of monetary policy came in the days when capital flows were more restricted than they are now, but financial prices were regulated. In those days – and I refer here to the period before the decisions in the early 1980s to allow markets to set the exchange rate and yields on government debt – the problem was basically one of monetary control: policy‑makers could not accurately control the amount of settlement funds available to the banking system because domestic policy actions to control these funds were often over‑run by foreign operations we had to undertake to clear the foreign exchange market at the nominated exchange rate.
He goes on to show how Australia just could not manage the 3 things together- price stability, rising inflows and currency management. However, despite all the attempts it just couldn’t stop speculation on currency.
Attempts to frustrate the speculators were unsuccessful. Inflows continued. Finally, the exchange rate was floated on 12 December 1983 and most of the remaining capital controls were removed simultaneously.
Australia was one of the few countries to have taken a decision to float when the currency was under upward pressure, because the capital inflow just could not be adequately absorbed. The decision has rightly been regarded as one of the most important ever taken by an Australian Government in the field of economic policy, for a number of reasons.
This speech must have delighted most economists who say RBI should let exchange rate float. However, at the end, he offers words of caution:
Of course, it took some time to get to this position. I recognise that many other countries in the region are in a different position. Many are more open, so with perhaps less scope to allow large exchange rate moves without significant first‑round inflationary or deflationary effects. Others are still working to develop stronger domestic monetary policy frameworks. Hence, these countries probably tend to worry more about the flightiness of international capital flows than do we. Nonetheless, it does seem to me that Australia’s experience offers reasonable grounds for thinking that, over time, these problems can be contained sufficiently so that we can enjoy the benefits of openness to capital flows without too much cost.
The crux of the speech is how Australia managed capital flows and let its currency appreciate. But he offers two valuable lessons at the end – 1) all the stability took time and 2) stage of development matters.
Now if we juxtapose the Australian experience with that of India, is it the right time for India to let rupee go? What are the costs and benefits for doing the same? The research and ideas should focus on the policy design given Indian conditions; not on whether RBI is doing things right or wrong.