A monetary history of Indo-Bangla acrimony
In a western magazine’s story covering the liberation of Dhaka in December 1971, a Pakistani officer is reported to have quipped that the Indians didn’t know what they were getting into. Another story from the same time showed that the Indians knew exactly what they were getting into, and was anxious to get out — an Indian general was quoted as saying the ‘Indian liberators’ wouldn’t overstay to become ‘Hindu occupation forces’.
It didn’t take long for a sharp rise in anti-Indian sentiment in the ‘Bangla bazaar’. While there are many reasons for this turn of events, I will discuss one particular cause: ‘the war booty’ factor. Even before the ink in the Instrument of Surrender dried on 16 December, there were complaints that the Indian army was ‘looting’ the new country. Over the following couple of years, a perception developed that India was ‘draining resources’ from Bangladesh. And the Mujib government’s alleged complicity in this contributed to his demise.
Much of this stuff is perceived, and the perception is well known to anyone familiar with the period. However, what is perhaps far less appreciated is that there is a solid economic basis for that perception, an economic basis grounded in exchange rate and money supply.
When Bangladesh declared independence in March, it didn’t have its own currency. The Bangladeshi authorities declared that Pakistani notes with an official rubber stamp would constitute Bangladesh taka — the new country’s currency — until such time that proper taka notes could be printed.
In 1971, one US dollar bought 4.75-80 Pak rupee. Obviously, officially stamped taka’s de facto exchange rate against the dollar was the same. Meanwhile, Indian rupee’s rate against the dollar was 7.50 or so in 1971. That is, Pak rupee (and thus taka) was stronger than the Indian rupee. In January 1972, Bangladeshi authorities set taka’s exchange rate at a parity with the Indian rupee. This meant a sharp depreciation of taka against the dollar as well as the Pakistani rupee (and conversely, an appreciation of Indian rupee against taka). The following charts show these.
These monetary decisions were to have serious consequences.
Firstly, depreciation makes imports dearer and exports cheaper. The thing is, in 1972, Bangladesh had nothing it could export to the wider world, and imported a lot of basic stuff like food and fuel. Thus, the depreciation against the dollar itself was inflationary.
Of course, the Indian rupee appreciated against the taka. This meant that whereas before the war, each Indian rupee could get only 60 paisa worth of goods in the erstwhile East Pakistan, it could fetch a full taka worth in the independent Bangladesh. Relatively affluent Indians took advantage of this and bought as many things as they could in Bangladesh. And the things they could buy included a lot of ‘foreign’ goods that was unavailable in the pre-reform India. Some of these goods were abandoned by the Pakistanis — household appliances or vehicles or other consumer goods. But more damaging for Indo-Bangla relations, they also included relief materials that were meant for the war ravaged country.
Ordinarily, this inflow of the Indian rupee would have led to a rise in taka’s price against rupee (that is, rupee would have depreciated and taka appreciated). But the decision to keep taka-rupee parity stopped that. The result was a rise in the supply of taka in the domestic economy. Since production was severely constrained by the war, what happened was a textbook case of too much money chasing too few goods — recipe for inflation.
There were further complicating factors.
During the war, to hamper the economy of the occupied Bangladesh, currency counterfeit operations were sanctioned by the Indian and Bangladeshi authorities. In the lawless days after the war, the counterfeiters got to work on their own. Of course, now they were destabilising the economy of Bangladesh, not East Pakistan.
Meanwhile, the Pakistani rupee was devalued to 11 rupee per dollar in May 1972, when taka and Indian rupee were worth about 7.25-30 against dollar (depreciating to 8ish over the ensuing months). There was a huge arbitrage opportunity in smuggling Pakistan rupee into Bangladesh and get it rubber stamped as taka. In the process, Bangladesh’s monetary system was hit even harder.
Some readers might have realised that the title of this post is based on Milton Friedman and Anna Schwartz’s masterpiece. But I could also have titled it ‘economic consequences of the peace’, after the Keynes classic. It’s now well understood by mainstream macroeconomists that the misaligned exchange rates after the Great War set the stage for the Great Depression and the political consequences thereafter. Europeans are also learning the hard way that politically motivated monetary decisions that disregard economic fundamentals can have adverse economic consequences, which could derail democratic politics itself.
In 1972, things as mundane as exchange rates and money supply created perverse incentives for profit-seeking people on both side of the border that soured the Indo-Bangla relationship, with far reaching consequences. Perhaps in 1972 we didn’t have experienced central bankers and econocrats to understand the full implications of their de facto currency union with India.
In 2012, we should know better. Let’s keep the history of 1972 in mind when we discuss Indo-Bangla economic integration in 2012.