Gandhiback Grievances

The interesting story of the day is definitely a rapidly “collapsing” Rupee haunted by abnormally high volatility over the past month. I scare quote “collapse” because it’s a term that reflects the Western bias of this conversation. If you’re an American who has invested in emerging market funds hoping for real gains intended for domestic consumption that beat an index well, then, you’ve been screwed. As far as India is concerned the depreciation is  of less concern. Still, Raghuram Rajan has his job cut for him, and I’ve discussed the Indian Rupee in this context before. However, since Paul Krugman blegs to learn what he is missing, I’ll offer a few things that worry me at the moment.

Primarily, like any other developing country with rentier bureaucrats, fuel subsidies are important to India twofold. First as a stimulant for middle class growth that demands transportation and electricity (generators are big); second as a key ingredient to important fertilizers without which the Indian farming model would fail.

Fuel subsidies pose an interesting problem for a country that will meet 90% of its oil needs through imports. (I mistakenly noted that 90% of oil is currently imported. That said, the greater the difference between the current figure and the future one, the worse one unit of depreciation will be). Basically all growth in India’s most important market will be financed from imports henceforth. On the one hand, the decisive role government plays in the energy market almost guarantees that deficits will face an upward pressure, in a time when yields are already rising. The sensible solution would unfortunately involve curtailing the provision of a good necessary for political success.

More importantly, as energy becomes the dominant theme in Indian trade – as it undoubtedly will – India looses the primary benefit of depreciation: exports. When trade structure is such that the cost effect (price of imports) of depreciation trumps the quantity effect (quantity of imports) the beneficial nature of depreciation is removed entirely. Known as the Marshall-Lerner condition, a country technically faces this dilemma when the summed price elasticity of imports and exports falls below one.

Usually, since goods tend to be price inelastic in the short-run, devaluations are not always immediately successful but work over time. Not so for dollar-priced oil. As the value of oil is already buoyed by demand from emerging markets, each point of depreciation for the Rupee is that much worse for its balance and budget. Using data from the International Financial Statistics and Direction of Trade Statistics from the IMF, Yu Hsing estimates that India may not significantly meet the Marshall-Lerner condition. Since the paper might be gated for some of you, I’ll copy the relevant result:

As the US real income declines due to the global financial crisis, the trade balance for Japan, Korea, Malaysia, Pakistan, Singapore, or Thailand will deteriorate whereas the trade balance for Hong Kong or India may or may not deteriorate depending upon whether the relative CPI or PPI is used in deriving the real exchange rate.

India – to my surprise – weathered a depreciation better than some of the other countries studied, but a statistically significant success was predicated on the deflator of choice to determine real interest rates.

While I am not confident that India fails to meet the condition, rising oil prices and domestic demand guarantees the cost and quantity effects may be a little too close for comfort.

That, of course, only considers the total trade balance. As mentioned, government is unlikely to weather the necessary inflation well, especially if Raghuram Rajan decreases liquidity reserve ratios (as he has wanted to do for a while) which would light an upward pressure on already rising yields. The feedback loops formed from a rising deficit, stalling growth, and decreased demand for Rupee bonds will result in unfortunately high interest payments.

A tangential point concerns rentiers like Reliance – owner of the world’s largest refinery – which benefit from rapidly rising prices in an inelastic-demand environment. Its influence in government, along with political concerns will make handling these ridiculously useless subsidies hell for any Democratic government predicated on shaky coalitions.

India has a lot going for it. A falling Rupee hardly highlights any structural problem insofar as its own domestic economy is concerned (but brings to bear important questions about international monetary systems, a discussion for another day). I am largely with Paul Krugman that this is nothing to fret about – we are still talking about a country where people cry about 5% growth – but am only cautiously optimistic regarding the political ramifications from such rapid depreciation. Krugman is right in principle, and sometimes that is not enough.

  1. Liam said:


    So many of your posts go into such depth, and I’m curious as to how you’ve picked up such a breadth of knowledge. I, like Dylan Mathews, thought you might have been 30, not 18. What have you found to be the best resources? Working through a Principles of Economics textbook can only get me so far, and blogs usually have posts for economists and non-economists without a bridge. Although both are helpful, there is a pretty big jump to a post like “An Inquiry Into the Efficacy of Ricardo’s Helicopter,” which I could only partially make sense of.

    On another note, since you are in the class of 2017 (so am I), I was wondering where you will be starting classes in two weeks time. That is, if you don’t mind me asking. I could only make an educated guess from this post:

    Anyways, I found this to be an interesting post. I’m sure this graph will look even more dramatic in a few years time.


    • Liam – thanks for the kind words!

      I’ve taken AP Economics, but that – or any Principles text – didn’t give me the “economics intuition” as much as consistently reading blogs and writing as much as I can. You’ll see that some of my earlier posts weren’t nearly as coherent as my later ones. While I still have a ways to go, a lot of that comes from finding my place in terms of tone, content, and understanding of economics.

      How I think of economics is vastly different today than it was four months ago when I got serious about writing. Much of that preparation came not just from reading posts but replying with a detailed study of relevant literature, FRED, etc.

      Some of the advice another very young blogger, Evan Soltas, gave me is here: and I think you may find that useful.

      I will be studying “Markets and Social Systems Engineering” at the University of Pennsylvania.

      Thanks again!

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