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G-7 endorses emerging markets' exchange rate policy, underlines full convertibility

R C Murthy in Washington

The group of top seven industrial nations have conceded that emerging market economies can have any appropriate exchange rate regimes, but full convertiblity should be the ultimate goal.

Any exchange rate regime, short of full convertibility, was frowned upon by the International Monetary Fund and G-7 till recently and Malaysia's going back to capital controls during the 1997 Asian contagion was criticised.

The effect of Asian crisis was that India suspended its march to rupee's full external convertibility. The then finance minister, P Chidambaram, had stated that the government would read every signpost carefully before moving forward. Since then, there is no talk about it. The report of Chakravarthy Rangarajan on the subject is shelved for the present.

Although India accepted article VIII of the IMF, agreeing to convertibility of current account, restrictions on foreign currency purchased for foreign travel continue.

But India's conservative approach to full convertiblity was lauded recently by Joseph Stiglitz, World Bank chief economist. He suggested many other countries in the region had rushed into full convertiblity, which means free movement of capital in and out of a country.

Since then, several studies were commissioned on arriving at an appropriate exchange rate regime for emerging market economies but there is no unanimity yet.

Now the IMF and industrial countries have softened their views on full convertiblity for everyone. They no longer frown upon managed currency floating, pegged or crawling exchange rates.

There is also recognition that Central Bank intervention has an important role in nurturing orderly market conditions, especially in exchange markets that are not integrated completely with domestic financial markets or lack the requisite depth and liquidity.

The G-7 decided at the weekend that industrial countries should not provide "significant" official financing for a country intervening heavily to support a particular exchange rate level, except where that level is judged sustainable.

Certain other conditions, like consistent domestic policies and a strong and credible commitment to support that exchange rate policy should also be fulfilled.

This will be a new conditionality. If a country unilaterally moves away from free convertibility, it will run the risk of aid suspension. Whether or not the temporary deviation is right will be decided by the IMF.

Aiming at preventing a repeat of 1997 Asian contagion, and the crisis in Russia and later in Latin America, the G-7 decided to create a new forum, called G-20, to monitor, prevent and grapple with such a crisis in future.

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