The Hindu Business Line : <I>The art of signalling</I>

Through all the brouhaha of the stock market crash, be it due to interest rate hikes in the US, the fall in the commodities markets, the draft CBDT circular apparently planning to tax FIIs or global downturn in equities, the India growth story has remained unchanged. From Monday afternoon statement — asserting his belief in the long-run Indian story to his pooh-poohing the FII taxation rumour — the Finance Minister, Mr P. Chidambaram, seems to be exactly what the doctor ordered. He has shown the right signals.

In a country that is increasingly reaping the benefits of globalisation, the financial architects do have a job cut out for them. Policy-makers can only make plans, but money is needed to make them a reality. Hence, the bourses, historically separated from the traditional govermnment spheres, can no longer remain so. Crucially, the Finance Ministry will not only have to learn to offer the correct hard packages for attracting capital, but will increasingly have to take on the role of a soothsayer, consultant and an opinion tweaker.

Talking of such strategic intervention, one is reminded of the former US Federal Reserve Governor, Mr Alan Greenspan. It was another Monday, February 7, 2005, and the currency market was in a panic. As the twin deficits in the US rose, the dollar slid sharply. The talk of oil being getting re-denominated in euros was not helping the dollar at all. Further, China was unwilling to re-value the yaun.

Pessimists were predicting that to get the American trade account in balance, the dollar would have to fall 40 per cent or more, or the world (excluding US) would have to grow by 65 per cent so as to boost American exports. The possibility of either happening being remote, the global markets seemed in mortal peril. At a special G-7 session, Mr Greenspan spoke of a tight Budget helping the US tide over the huge deficits. The G-7 meeting also put pressure on Beijing to revalue the currency. Together they achieved what had seemed impossible only a day before the dollar gained and reached a three-month high against the euro.

However, giving signals can go wrong badly too. For instance, the exchange rate mechanism crisis in Europe in 1992. The European countries (including the UK) had pegged their currencies to the "core country", Germany, to see if a stable relationship and, eventually, a monetary union would be possible. When the Berlin Wall fell and Germany's deficits started growing, the German central bank put in a contractionary monetary policy to control inflation. Even as interest rates in Germany rose, capital started to move in from other countries. The UK, which was in a recessionary phase then, could not raise rates and faced a huge loss of forex reserves. Speculators were growing nervous about the UK's ability to be pegged to the Deutsche mark.

To convince the markets, the Bank of England started buying huge quantities of DM in the market. However, this was perceived as a signal of panic and speculators started switching from sterling pounds to dollars. What resulted from the signalling was a currency crisis.

Signalling is an art. It has to be done strategically to reap the best results. The Finance Minister seems to have the knack.

(The author is Economic Advisor, Mahratta Chamber of Commerce, Industries and Agriculture, Pune.)

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