China's yuan up, can we catch up?

My first article in the FE.

Common currency unit back on mainstream debate

The Asian Currency unit was a much talked about affair and was probably the most important currency unit debate since the ECU idea. Today, Central American countries such as Honduras, Guatemala, Nicaragua, have reached an understanding to promote a common currency unit and also a regional passport in their effort to promote regional cooperation.

In this light, it would be interesting to see if a CCU is warranted in the South Asian region. While there is no economic reason to prevent such a unification, South Asia's numero-uno obstacle is its political instability. What are the pressing economic concerns that promote such a possibility?

The present monetary arrangement has the Indian rupee on the forefront with Bhutan and Nepal relying on the Indian monetary policy actions to shape their domestic monetary policy. This has helped their economies in multifarious ways. Notably, because Bhutan and Nepal has India as its major trading partner, the business cycle synchrony allows for a regional peg to the INR. Further, currency trading does not happen on the BTN or NPR and they are convertible into INR freely. Business cycle in Bangladesh also co-move with the Indian business cycle. (While there is no substantive empirical research available on this front, preliminary evidence with quarterly y/y GDP suggests the same). The Srilankan monetary arrangement was heavily dependent on domestic political considerations and now that the war with LTTE has come to an end, a lot of internal cleaning up of macroeconomic policy framework is essential. Under this circumstance, a peg to the Indian rupee and arrangements to prevent debt monetisation will allow for macroeconomic stability for the economy. With Pakistan, potential for trade is enormous and the underlying economic conditions are very much similar to the Indian environment. The RBI was its central bank until SBP was formed and with a cordial political environment, a monetary unit can provide economic stability. With this the case, the RBI (may be an RBSA (south asia)) is no more a national entity, but a regional one such as the ECB. Profit transfer from operating a central bank could be shared on a mutually agreeable basis and the basic operational framework of the central bank could be similar to that of the ECB.

On the microeconomic benefits, the single most important benefit of a CCU is that of reduction in transaction costs. The mini monetary arrangement with Bhutan and de facto with Nepal has shown that with increased trade integration such an arrangement can reduce transaction costs through reducing production and distribution costs. Of course the basic requirement for such an arrangement to function is a fully operational SAFTA (South Asian Free Trade Agreement) which has similar duty and tax structures across the board. Externally, none of these economies are oil producing and in that sense have similar external threat to price stability.

A case for a RBSA is imminent, with the economics behind it being favourable. Like the stumbling block for the European countries, politics of it all will need to be sorted out and foremost of this issue is a resolution to the Kashmir issue. The present cordiality between Pakistan and China may also be an important obstacle in this formation.