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Opinions & Views
Political economy of currency devaluation
Jamaluddin Ahmed

          GOVERNMENTS can try to do as little as possible and let the currency system work on its own or they can impose strict controls over dealings between a country and the outside world. They can also choose something in between. This introduction of the choices as a way of responding to a deficit payment or the depreciation of a nation's currency has led to the identification of five options available in the economic literature: First, financing the overall payment deficits without adjusting the exchange rate or the condition of national economy; second, exchange controls; third, floating exchange rates; fourth, permanently fixed rates; and fifth, exchange rate compromises. Under option five, nations can try a mixture of options three and four by letting the exchange rate handle some adjustment tasks but not others. These are reasons why governments in developing countries have not been able to reform exchange rates despite widespread agreement among senior civil servants that severe over valuation of domestic currency can seriously hurt developing countries.
The system of administrative allocation of foreign exchange was extremely useful in rewarding clients because in a climate of great scarcity, the allocation of import license was a powerful means of developing and retaining constituencies. Many of those benefited from the overvalued exchange rate were either in government or had become the primary supporters of successive governments.
The urban populations are the chief consumers of imported goods and they are benefited from overvalued exchange rate and would be hurt by any kind of devaluation. It can also be pointed out that wherever there is a devaluation of currency, the ordinary people suffer most from the resultant price increase, unemployment and social services or impacts.
The existence of a powerful psychological attachment to the idea of strong currency has always been quite prevalent. This idea is not easy to describe, but the concept of a strong currency appealed to many supporters of the policy. The need to have a strong currency is tied to the desire of people who had seen their once proud country decline to bankruptcy. Politicians and civil servants in developing countries try to recapture some of the nationalists' spirit of the past by confronting international financial institutions. Sentiments of many economists lean towards the IMF being some sort of a sadistic monster, which cannot stand the sight of happiness in developing countries. Esteemed leaders like Nkrumah of Ghana, Sheikh Mujib and Tajuddin of Bangladesh, have rejected the IMF pressure to devalue their national currencies during the early 1960's and early seventies respectively. Unfortunately most leaders after Nkrumah, Sheikh Mujib and Tajuddin have not had the courage to stand up to the IMF pressure, and most governments of developing countries spinelessly yield to the IMF on the issue of currency devaluation.
Given the widespread belief on stabilisation through devaluation, political leaders in developing countries, in fear of losing their positions in the government, chose a politically essential but economically disastrous policy to remain in power.
Devaluation requires a leap of faith by the national leadership because while the injurious effects are guaranteed to be immediate, the beneficial effects take some time to take effect and are always viewed with skepticism since success stories based on IMF devaluation prescription are hard to come by.
Psychological aspects of resistance to exchange reform have been found to be quite prominent in the developing countries. General opposition to IMF and WB usually build up around the exchange rate. In many developing countries, resisting devaluation has become, for better or worse, an important nationalistic symbol. For example, in early 1980's both Nigeria and Tanzania resisted devaluation because of the psychological impediment. This aspect of the developing country politics may seem peculiar to westerners, who are inclined to see exchange rates as just another aspect of the economic policy, but psychological and nationalistic aspects of currency devaluation have become intertwined with leadership fears of a coup, the emotions against devaluation has become a formidable barrier to reform.
The Marxists see devaluation under foreign pressure as insidious while many Social Democrats view the process simply as an additional means of preserving an international economic system biased against the least developing countries. In the 1960s, western neoclassical economists tended to be confident about their ability to define precisely a country's resource needs and this led to the confidence against the legitimacy of intervention and carrying out of devaluation under pressure.
The government officials express concern about the political implications of continued exchange rate reforms. Their view can be recorded as the burdens that tend to flow from currency adjustments and that fall disproportionately heavily on the deprived and poorer sections of the community without adequate and corresponding compensatory benefits. This sector of a developing country is the constituency representing a vast majority of general mass that must not be unnecessarily burdened in the pursuit of growth. Mostly, financial officials in the developing countries think that exchange rate announcements have become more and more difficult with successive announcements of devaluation because devaluation seems to increase substantially the possibility that Finance Ministers of the developing countries will lose their jobs.
Moreover, government officials have admitted that they faced too many popular pressures simply by trying to continue the practice of administrative announcements of devaluation. The process of setting exchange rates administratively can be cumbersome to continue indefinitely because this is done in most developing countries, under pressure from the politician at ministry of finance while decision is declared by Central Bank enjoying little independence. In addition, devaluation can hurt a majority of constituents in the developing countries; therefore, explicit supporters of devaluation are relatively scarce.
Devaluation of currency has severe adverse effects on liquidity of foreign exchange borrower industries in the most ruthless way and it affects moderately foreign loan indebted countries (Ahmed 1996; Cooper 1971, Richardson 1989; Denon 1986). Potential constituencies for the government who benefit from currency devaluation are those who are in export related industries. The business community views the lack of professional representation as an opportunity for ventilating more problems. Proper participation in crucial decision-making processes of devaluation is strictly required.
History provides evidence that policy makers have always been shy about the devaluation decision on political grounds. National prestige and local pride frequently are factors that inhibit resort to currency devaluation. Another significant deterrent is the apprehension that it will spell political disasters for those responsible for the decision. A government may have fallen just before devaluation as a result of economic mismanagement or for some other reasons, leaving for the successor an opportunity to blame the necessity for devaluation on the fallen government. A government may delay the devaluation to a time which is thought politically safe. Most importantly, devaluation is often a necessary consequence of economic mismanagement. As such devaluation should be, and often is, the target of political criticism.
Cooper (1971), in his study on effects of currency devaluation in the 24 developing countries including political aspects, found that seven out of the 24 governments have lost power in the year following devaluation. The king of Morocco removed his Prime Minister because of the latter's liberal and modernising inclinations. General Park's 1961 coup in Korea followed mismanagement of the economy and the decision of currency devaluation has contributed to the general dissatisfaction. Costa Rica and Columbia (1965) had both experienced change of government on the charge of economic mismanagement. In Peru (1959) and Equador (1957), economic mismanagement, leading to the necessity for devaluation, had played a substantial role in the change of government. Conservative Party in Canada (1962) had lost parliamentary strength and fell after one year and so did the congress in India (1966). In Israel (1962), devaluation and associated economic policies led to a hotly defeated motion of no confidence, however, the government survived. The coup in Turkey (1960) followed a strong widespread dissatisfaction with the economic policy. Cooper's (1971) study found that finance ministers were more afraid than the governments on the matter of devaluation. Fourteen out of 24 failed to stay in their jobs during the 12 months following devaluation. All these seven went with the government of course, but in other countries such as Argentina, Columbia (1962), India, Korea (twice) Pakistan and Philippines the ouster took place when the government stayed. In a developed industrialised country like England, currency devaluation is viewed as a symbol of defeat and the authority's failure to contain market forces as well as to provide stable basis for economic growth (Cairncross and Eichengreen 1983). After devaluation of UK pound in September 1992, Chancellor of exchequer, Norman Lamont, lost his job with a few months.
Price (1984) stated that successive civilian and military governments in Ghana continually distorted prices, exchange rate, and public enterprises in order to encourage clients and to enrich themselves. Herbest (1989) provided Ghanaian history of exchange rate problem that began with economic crisis in the early 1970's and reported overthrow of Prime Minister Busia's government by military coup after a surprise devaluation of Ghanaian cidi from 1.02 to 1.82 to the dollar rate. In order to gain popular support, the military government revalued cidi to 1.28 to dollar.
Following the difficulties experienced in 1973-74, Bangladesh succumbed to IMF in return for being allowed to borrow further tranches of its quota. On 22 May 1975, devaluation of Bangladesh Taka took place, removing the Finance Minister, Mr. Tajuddun Ahmed, who was also the first Prime Minister of the Bangladesh government, when the worst of the crisis was over (Faaland, 1981). Bangladesh experienced military coup and witnessed the overthrow of civilian government (Aug 1975) following a decision of major devaluation of Bangladeshi Taka. Since independence, the conscious effort of Bangladesh was to minimise use of foreign aid and reduce interference of outsiders in the economic management. Contrary to this, since 1972 the IMF has consistently held the view that Taka was overvalued, and devaluation should be undertaken immediately. Bangladesh was reluctant to do so. Even though there was a meeting of minds on the basic merits of currency devaluation, Bangladesh resisted and refrained from devaluation for three years; finally devaluation took place in May 1975 (Falland 1981). Critics argue that first finance minister, Tajuddin Ahmed, who was one of the founders of modern Bangladesh, lost his job as the consequence of differing opinions over the issue of IMF conditionalities, use of foreign loans, and currency devaluation. After the removal of finance minister, Bangladesh currency was devalued from BDT 7.30 to 15.05 on May 22, 1975. Events that followed the removal of finance minister was the cruel killings of the father of the nation and his family members on 15 August. The value of Bangladesh Taka against USD in 1972 was Tk 7.30 and Tk 15.05 up to August 1975 when the Awami League led the government. Taka/dollar conversion rate was BDT Tk 20.03 for $1.0 in 1982 and it was 35.67 in 1990. The rate was BDT 40.83 in 1996. I rose to BDT 53.95 in 2001 and subsequently it was BDT 70. Currently, the nation is waiting to see the final score of BNP at the Taka/dollar exchange rate. From this information, it is very easy to quantify the share of currency mismanagement and failures of respective governments during last three decades that turned Bangladesh into a Foreign Loan Affliction Syndrome Economy.
Available evidence has demonstrated that Indian Prime Minister Shastri (1965) took steps divergent from Nehru's rigid course of currency management by increasingly leaning toward decontrol and greater reliance of market. Shastri fired his powerful finance minister, Krishnamachari for being one of the outspoken opponents of devaluation and decontrol. Krishnamachari refused to listen on and discuss IBRD report on devaluation and decontrol. In addition, the finance minister also prevented the report of IBRD on India being disseminated within government, delayed passing it to the Prime Minister thus postponing the possibility of action on its recommendation. Interestingly, the top Indian civil servants of the finance ministry became disillusioned with the control and found strongest inside advocates of greater reliance on decontrol and devaluation. When civil servants themselves began to play a greater role in policy formulation on devaluation and decontrol, Sachin Chowdhury, a career lawyer, was picked up as finance minister.
In the developing countries, smaller numbers of individuals considerably influence devaluation decisions on the argument that an important characteristic of such decision in the bureaucratic manipulation is based on secrecy. This is done to limit the possibility of speculative demand and as a means of thwarting criticism by ministers and top civil servants whose inclusion might delay or alter devaluation package (Denon 1986). Indian Prime Minister, Mrs. Gandhi (1966), had to consider the question of whether the decision of devaluation was politically worth the risk. She had to decide by making a choice among difficult alternatives. Tightening control and delaying decision-making until after 1967 general election would have been politically acceptable, but it would have lost or postponed the chance for sizable increase in aid programme. Outside her congress Party, Mrs. Gandhi could not discuss the issue of devaluation with the left, and her decision to rely on foreign resources made it impossible to generate nation-wide sentiment in favour of devaluation.
Mrs. Gandhi's intuition and boldness worked well in negotiating a secret understanding with the donors, but failed to mobilise the necessary political support for 1966 devaluation. Mrs Gandhi's subsequent behaviour demonstrated that she hoped to keep her options open not to identify herself too closely with the devaluation but the last and most curious aspect of her decision process was that she seemed not have any specific fallback plans if the venture failed. The political impact of liberalisation and currency devaluation decision of 1966 had an impact on February 1967 general election when congress Party lost majority in one third of state legislative assembly for the first time after 1947 independence. All India congress President lost in the election in his own Tamil Nadu District. This election result naturally influenced Mrs. Ghandi to return to the classic political strategy learned from her father 'talk left but hold the centre' and sacked two pro-American ministers like Asoke Mehta and Subramniam to gain support of the left. Similarly, in the year 1992, India took a bold step on deregulation and devaluation and this had adverse effect on election result of 1996 and 1997 with humiliating defeat of Congress Party since 1947.
Thus, there is a dilemma with respect to macroeconomic management in the period immediately following devaluation, and in the end, the authorities must inevitably tailor their policies to the particular requirements of the country. Short-term economic management of this type remains very much an art. At the same time, the apparent political consequence of devaluation and increased probability that those governments will lose their positions and ministers their jobs is unsettling. This means that there may be a sharp conflict between the personal interests of those in authority and the interest of the nation, a conflict that has to be resolved at the expense of the country. This divergence in opinions perhaps plays an even greater role than the 'social contract' considerations outlined earlier in leading procrastinations over devaluation and an attempt to substitute ad-hoc restrictions and subventions. Thus, it would be desirable to de-politicalise the whole question of devaluation by making it less traumatic both for the officials and for the public. This suggests another reason, in addition to more strictly economic ones, for moving toward greater flexibility of exchange rates along the lines of gliding parity. Gradual changes in exchange rates would not only eliminate the political jolt and major economic dislocations, which could take place following a large discrete devaluation, with sharp alteration of relative prices and hence factor incomes, but would also help avoid the major misallocation of resources that takes place as a disequilibrium builds up under a fixed exchange rate.
The writer is the Vice President of the Institute of Chartered Accountants of Bangladesh and Treasurer of Bangladesh Economic Association


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