A couple of years ago, Governor Y V Reddy had argued that "a view needs to be taken on capping FII flows into the markets. Price-based measures such as taxes could be examined though their effectiveness is arguable".
At that time, the stock market reaction provoked the finance minister to promptly deny that any such measure was under consideration. What happened in Thailand last week was much more embarrassing: with the approval of the finance minister, the central bank first imposed a 30 per cent margin on all fresh foreign inflows.
As the stock market fell 15 per cent in reaction (the largest one-day fall since 1990), within 24 hours, it reversed itself and exempted equity investments from the margin requirement! It was a dramatic reversal of policy evidencing an inept, confused government.
Last week's Thai measure was prompted by a 16 per cent appreciation of the currency in the current year. They would hardly have forgotten the dangers of allowing the domestic currency to appreciate in real terms, on the basis of capital flows, as manifested in Mexico in 1994-95; east Asia, including Thailand itself, in 1997-98; Argentina in 2001; and so on.
They obviously do not see much virtue in the consumption-led growth fueled "when the (domestic currency) is strong and imports are cheap", a strategy advocated by Ila Patnaik in a recent article in The Indian Express (December 16). Incidentally, the ineptness of the Thai U-turn itself may rattle and damage foreign investor confidence and reduce inflows - which is what the margin was aimed at.
December was also witness to another controversy on exchange rate policies, this time in the pages of Financial Times. The provocation was an article by Vijay Joshi of Oxford University, advocating the need for some kind of managed exchange rates between major currencies.
At least two academics, one in Hong Kong and one in the US, have criticised Joshi's views in letters to FT. The former has argued that "domestic cost adjustment can deliver a smoother path to equilibrium in the real rate, provided that costs are able to move flexibly and fast enough, down as well as up."
What a proviso - he should be put in charge of negotiating lower wages with employee unions, when the domestic currency has appreciated! He must be living in an entirely different world, away from the real economy, to believe that domestic cost adjustment can be "smoother".
On the other hand, even if such cost adjustment were to be smooth, is this not also a management of the real effective exchange rate? So what is wrong with doing this more directly through the nominal exchange rate? Or, should the problems of sterilisation outweigh the damage to the real economy which misalignment of exchange rates can impose? Incidentally, George Soros, during his recent visit to Delhi, did not seem very enamoured of "fully floating" exchange rates.
But leaving this debate aside, the world economy has generally fared well over the year, with equity markets everywhere booming. It is remarkable that robust world growth has continued, despite the high oil and commodity prices; and inflation worldwide has come down thanks to globalisation.
Barring a disorderly fall of the dollar, which is the major imponderable in the current world economy, both these trends should continue in 2007 as well, with IMF and OECD forecasting slightly lower growth in the US but higher in Europe. Japan is also on the upswing - and Chinese growth remains in double digits despite efforts to cool it.
Among other notable developments in the world economy, one was that New York seems to be losing its leading position as the largest capital market, to London, thanks partly to the cost and cumbersome compliance requirements flowing from the Sarbanes Oxley Act.
This is benefiting other capital markets as well with Hong Kong and Shanghai recently handling the world's largest ever IPO issue - $ 22 billion from the Industrial and Commercial Bank of China. The success of the issue evidences the capacity and depth of these two markets. Incidentally, the Chinese exchanges raised a combined $43 billion in the first 10 months of the year, compared to $40 billion of IPOs on the UK markets, and $38 billion in the US.
In the political economy, there were two major developments. First, country after country in South America voted in left of centre governments, much to the annoyance of the giant neighbour in the North.
The list included Venezuela, Bolivia, Equador, Nicaragua and Brazil. Russia started flexing its oil muscles, strengthened by the high oil prices. Along with other oil exporters, Russia announced that it would diversify reserves away from the dollar.
But the key to the US currency's exchange and interest rates remains in Beijing, which is sitting on a trillion dollars of foreign currency reserves.
