IPS obtained approval for its research proposal on "Monetary Cooperation in South Asia" at the fourth round of research studies commissioned by the South Asia Network of Economic Institutes (SANEI), funded by the World Bank and coordinated by the Indian Council for Research on International Economic Relations (ICRIER), New Delhi.

Rationale

The vision of an integrated South Asia continues to animate policy initiatives undertaken within SAARC. Though the political obstacles to such a vision appear daunting at present, the on-going process of liberalization in all countries of the region ensures that the choice of optimal exchange rate regimes and associated issues of regional monetary cooperation, including even common currency areas, remain on the regional policy agenda. Significant new theoretical work on optimal exchange rate regimes, and perhaps more importantly, the impact of recent international developments, particularly the launching of the Euro, has given this issue increasing prominence. Politically, though, the issue of a common currency remains a sensitive issue. At least for some subgroups of countries, the will to overcome political barriers may no longer be a binding constraint if monetary integration would demonstrably offer sufficiently large net economic benefits.

Objectives

An important aim of our research is to identify differences in historical patterns of monetary and fiscal policy across countries, and to examine whether the non-synchronization of business cycles in different countries can be attributed to differences in monetary and fiscal policy, rather than to differences in supply or external shocks that impact on countries. Econometric techniques will be used to analyse these issues for South Asian countries. It is hoped to begin by addressing issues such as what form a currency union should take, and what is the best process, i.e., transitional steps, to get to any proposed union. Some preliminary explorations will be made on the adjustment processes necessary in order to proceed to a currency union for potential currency union member countries. Before issuing one currency, participants in a currency-union need to harmonize inflation rates and monetary policy, and, to some extent, fiscal policy as well. There are a number of possible adjustment paths, and this paper will consider the implications of alternative monetary and fiscal regimes available to countries along the path to currency union. The study will also draw on the recent literature that analyses situations of a common monetary policy regime in the absence of a common fiscal policy.

The study will pay close attention to the political and institutional context. It will build on and extend the available analytical work on SAARC monetary cooperation, and assess the economic benefits of various monetary policy cooperation options among different country groupings, with close attention to the political and institutional contexts. The study will also address, for the first time, the implications of alternative monetary cooperation choices, including alternative exchange rate choices, in South Asia.