E-Paper
Rethinking India's exchange-rate debate
This article is authored by Abhaya Abhayankar, former professor of finance, University of Exeter, UK and Atul Chaturvedi, former secretary, Government of India.
The real exchange rate rarely features in India's economic debates, yet it drives competitiveness. When domestic inflation outpaces trading partners', even a stable nominal rupee appreciates in real terms. This quietly erodes export competitiveness and makes imports relatively cheaper. In effect, such real appreciation mimics a broad reduction in tariffs and can dampen industrial growth. On this narrow analytical point, critics are right: The real exchange rate matters, and it deserves more attention than it receives.
However, the argument becomes less persuasive when invoking East Asia as a model. South Korea, Taiwan, and China did maintain undervalued currencies during their high-growth phases—but they did so under fundamentally different conditions. These countries were cohesive, often authoritarian states. They could suppress wages, impose capital controls, direct credit, sterilise large interventions, and maintain disciplined inflation. India, by contrast, is a federal democracy with independent capital markets, electoral volatility, and an inflation-sensitive electorate. The institutional levers that powered East Asian undervaluation simply do not exist here—nor should they in a democratic polity.
Global conditions have also moved on. East Asia industrialised during the 1980-2010 period of expanding global trade and rising labour-intensive manufacturing flows, with the U.S. tolerant of large Asian surpluses. Today, manufacturing growth is stagnant. Automation is diluting the advantage of cheap labour. Supply chains are consolidated around China, and geopolitics has increased trade frictions. No amount of exchange-rate management can recreate the world of the East Asian experience.
India's own macroeconomic constraints compound the difficulty. Inflation persistently runs above that of major trading partners, meaning nominal depreciation quickly feeds into higher domestic prices, neutralising any real-competitiveness gain. Sterilising large-scale interventions imposes heavy quasi-fiscal costs. And large, volatile capital inflows tied to global risk cycles routinely overwhelm central-bank efforts to influence the currency. The real exchange rate is an outcome of inflation, capital flows, productivity and expectations— not a lever that can be set by fiat.
These constraints do not imply that India is doomed to real appreciation or weak manufacturing. They suggest that turning the real exchange rate into a policy target is not viable in practice. The more realistic strategy is to smooth volatility, manage speculative inflows through prudent macro regulation, and focus relentlessly on structural reforms that raise productivity and reduce domestic costs. Better logistics, improved infrastructure, and a larger role for tradable services can deliver competitiveness gains that currency manipulation cannot.
So where should policy focus? On the fundamentals that actually move productivity. Recent and ongoing reforms to labour laws, municipal governance, and administrative structures should be viewed through this lens. India's overly complex and State-heavy regulatory framework has for decades crowded out private initiative and entrepreneurship. Young Indians overwhelmingly prefer government jobs not only because they offer security, but because the returns to innovation and formal-sector risk-taking remain uncertain relative to rent-seeking opportunities. This is Baumol's famous misallocation problem: Too many of the country's most capable people are pulled into low-productivity, low-innovation roles because the incentive structure points them there. A lighter, more transparent regulatory state—one that enforces rules predictably rather than proliferating them—is central to shifting talent and capital toward productive enterprise.
Cities and urban agglomerations are often engines of growth. Bangalore, Chennai and other smaller clusters are examples. However, municipal administration remains over-regulated, under-funded, and insufficiently empowered. Without more dynamic, better-governed cities, India cannot achieve the scale and density that modern manufacturing and services demand. Urban reform is as critical to competitiveness as tariff reform or exchange-rate policy.
Agriculture, too, needs attention. Fragmented landholdings with low capital investment and low productivity can be addressed through cooperative arrangements, leasing reforms, or market-based land consolidation—paired with modern irrigation, logistics, and technology. This could free labour for more productive sectors while raising rural incomes. Larger, more mechanised farms and plantation-style enterprises can co-exist with smallholders if the State enables, rather than obstructs, such evolution. The question of absorbing excess agricultural labour into industry or services is difficult, especially in a democracy with a large farm-based electorate. But without this shift, and without providing this labour with useful skills and enriching human capital, durable growth remains elusive.
The real challenge before India is not to replicate an East Asian currency strategy from a bygone era—it's building an institutional foundation fit for today's world economy. India's macroeconomic constraints make the real exchange rate an outcome, not a lever. So target what can actually be controlled: logistics, energy costs, urban governance, agricultural structure, and a lighter regulatory state that rewards enterprise over rent-seeking. Exchange-rate smoothing may help at the margin, but only productivity-led transformation can deliver durable competitiveness.
This article is authored by Abhaya Abhayankar, former professor of finance, University of Exeter, UK and Atul Chaturvedi, former secretary, Government of India.
