A monetary history of Indo-Bangla acrimony

Posted in 1971, economic history, economics, history, macro by jrahman on July 15, 2012

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.

Using the research of Akhtar Hossain (an Australia-based Bangladeshi economist), I explain it over the fold, and speculate about a couple of things.

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.


5 Responses

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  1. Diganta said, on July 16, 2012 at 11:46 pm

    “Relatively affluent Indians took advantage of this and bought as many things as they could in Bangladesh. ” – How many Indians used to live in Bangladesh in 1972? Given your explanation, there should have been a deluge of foreign goods in West Bengal at the similar times. I didn’t know of any …

    • jrahman said, on July 19, 2012 at 5:05 pm

      In early 1972, there were over 100,000 Indian army and civilian personnel as part of the Allied Forces (Mitra Bahini). It would have been perfectly legal for them to buy stuff in Dhaka. Note, the story doesn’t require Indians to physically be in Dhaka to buy things. The point is, there was an outflow of goods from Bangladesh to India, and inflow of hard cash from India into Bangladesh. Given the de facto monetary union and lack of production in a war-ravaged country, this transaction led to inflation. And in popular psyche, the whole thing became ‘India robbing us’.

      Also, there was a scale effect. In 1970, Dhaka had a population of 800,000, while Calcutta or Bombay were cities of millions even then (no reason to think why luxury foreign goods would stay in West Bengal). Suppose there were 5 major brand electrical appliance in Dhaka and 50 in Bombay before the end of the war. If 3 of these were bought buy Indian officers and taken to Bombay, their absence would be a huge deal in Dhaka, but a minor issue in Bombay.

      • Diganta said, on July 20, 2012 at 12:16 am

        I understand. But I don’t see anything that could have been done better. Mitrabahini stayed in Bangladesh for a very limited period (3 months?). I am not sure how that could have been corrected. On the other hand, the pegging of Taka happened in 1972 January. So, the overlapping 2 months is too low for causing any issue in an economy.

        On the other hand, Bangladesh’s market driven exchange rate landed it lower than that of India’s … after 3 decades. So, the correction probably would have been there anyway. On the other hand, Bangladesh management had little understanding of the entire process and impact as they were starting anew.

      • jrahman said, on July 22, 2012 at 8:33 am

        Indian forces left within months, but the border was still open, and there were tens of thousands of armed young men able to cross it without much trouble. The original purpose of building the infamous barbed wire fence wasn’t to stop undocumented workers, it was to stop cross-border smuggling of things into India.

        But you’re right about ‘what could have been done better’. This stuff is hard, as we are seeing in Europe, where they have much better trained and experienced econocrats than what Bangladesh had in 1972. Sometimes terrible things happen, with long term consequences, without being anyone’s fault. This is one of those things.

  2. Mahamudul haque said, on April 15, 2014 at 6:38 pm

    For take a man. Carry after taken.
    Like ana paisa
    Unlike rupe taka
    economic for people.

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