Context: The global currency regime is about to collapse, and India will have to reset its policies accordingly.
Evolution of the global currency regime:
Fixed Currency Regime till 1970:
Disadvantageous for developing countries as they pegged their currencies to the US dollar, fixed exchange rates frequently led to surges in capital inflows, overheating the economies.
Spike in Inflation: Inflation rates spiked from time to time despite the commitment to low inflation
Dependence on Financial institutions: Due to trade and current account deficits, emerging economies found themselves at the mercy of international financial institutions.
For, E.g. as seen in the Asian currency crisis of 1997-98. This cautions developed countries in maintaining a de jure peg to hard currencies and float their exchange rates.
Bretton Woods II- End of Fixed Currency regime in the 1970s: Developed nations moved away from the fixed current regime when after the abandoning of the Breton Woods system.
America began to fret about the economic success of its former enemies—Japan and Germany
Tight monetary policy: In order to achieve competitiveness, it decided to follow an accommodative monetary policy and allow inflation to rise.
War effects: At the same time, its fiscal deficit began to widen due to the Vietnam War.
Recession: American recession in the 1970s accelerated the decline of the dollar.
Inflation: US attempt is to generate inflation and keep real interest rates as low as they were in the 70s
Impact of Bretton Woods II on developed nations:
America's general government debt-to-GDP ratio declined from around 55% in 1961 to around 35% by the end of the 70s.
In the UK, the net public debt-to-GDP ratio declined from 100% to 40% during the same period.
Impact on developing nations:
De-facto fixed exchange rate regime: Although the Bretton Woods system of fixed exchange rates was dismantled in the 70s, there has been a de facto fixed exchange rate regime, with the dollar as the anchor currency.
Conclusion:
The objective of developed countries: The unstated objective of developed countries (including America) for the 2020s is stealth inflation, thus inflating away the debt burden.
India's options: It includes matching that repression, pursuing a strong rupee, a re-imagined monetary policy regime, and capital controls. The status quo looks infeasible.