Since consistency is said to be the virtue of a fool, I should confess to being one: for more than a quarter century, I have been advocating an undervalued exchange rate. I also remain a proponent of managed exchange rates in preference to a clean float.

No wonder, therefore, that I am getting increasingly concerned about the exchange rate: last Thursday morning, the dollar: rupee rate was around Rs 43.14. In terms of the six-country REER model, this represents a 10 per cent overvaluation in real effective terms.

To be sure, the exchange rate is competitive in terms of services exports although the steep rise in real estate prices and in employee compensations, would erode this competitiveness also -- unless the industry keeps moving to ever higher value added services. However, if employment generation is to be considered the first socioeconomic priority, as I do, growth in services exports will not ease the situation significantly.

If rural incomes are to grow, hundreds of millions will need to move from agriculture to manufacturing industry and services. It is also difficult to believe that the domestic services sector will continue to grow except on the shoulder of a flourishing manufacturing sector.

Unfortunately, while there has been continued, and fast, increase in manufacturing output, much of this has not added to employment. For this we need labour intensive industries which can employ a large number of relatively unskilled people -- in other words, garments and toys, low-tech electronics, furniture and so on. And the quickest way of making a thrust in this area is through exports -- exactly what China has been doing for a quarter century now. To facilitate such exports, we need an undervalued exchange rate, something which we seem to be forgetting.

One is already seeing the effect of the uncompetitive exchange rate on the merchandise trade balance. Consider the April to February data released last week. It discloses a trade deficit of $56 billion. The data are on customs cleared basis and, therefore, while capturing most of the merchandise exports, exclude imports like defence goods, aircraft and ships. From the merchandise trade data, it is clear that the trade deficit this year could well be between $70-75 billion, a huge amount by any reckoning!

Not only is the number large in absolute terms, but it is likely to be more than 60 per cent of India's merchandise exports, a ratio paralleled perhaps only by the United States. While exports have been growing -- and many point to this as evidence that the exchange rate is competitive -- the fact is that export growth (23 per cent) in April-February has been much lower than import growth (31 per cent).

This remains true even in respect of non-oil imports and exports. I have been able to lay my hands on exports of petroleum products only up to November '06, but the evidence is that from April to November '06, exports of non-petroleum products grew 20 per cent while imports of non-petroleum items grew an even higher 22 per cent.

Inasmuch as exchange rate affects trade numbers with a lag, the full impact of the continued overvaluation will be increasingly felt in the current year: February data suggest that while exports grew by barely 8 per cent, imports grew three times faster! And, this even before the recent rise in the international price of oil! The current account deficit was a better-than-expected $12 billion over April-December 2006, but net of the "exogenous" element of private remittances ("transfers"), it was as high as $32 billion, or say 5 per cent of the GDP: whatever the accounting convention, remittances are substantively capital flows, not the economy's current "earnings".

Is too much of the thinking of the central bank getting governed by the need and cost of sterilisation, and the convenience of monetary aggregates, with other factors being either ignored or overlooked? From a broader socio-economic perspective, the dangerous drift which has led to an uncompetitive exchange rate, could prove as much of a handicap in terms of growth and employment and the reduction in rural poverty, as the inability or unwillingness of our political masters to propagate the need for industrialisation in its proper perspective, a point I argued last Monday.

While an overvalued exchange rate may look attractive from an inflation perspective, it is also leading to a sharp increase in external borrowings. In the first three quarters, external commercial borrowings increased $10 billion. The increase in supplier credits etc would also be large, but reliable data are not available.

The Congress Culture

In the context of my comments in last Monday's article about Rahul Gandhi and the Congress culture, I was very happy to read the prime minister paying a richly deserved tribute to P V Narasimha Rao, describing him as "truly a sanyasi in politics�a moderniser steeped in our tradition and ethos � (a) rare scholar, a statesman who gave a new sense of direction not only to our economic but also foreign policies." Well said, Sir!