TARGET AND INSTRUMENTS FOR THE EXTERNAL SECTOR WITH AN OPEN CAPITAL ACCOUNT

The move to a market-determined exchange rate system alongside in priv ate capital flows has constrained the authorities from using the excha nge rate essentially as an instrument since ensuring a stable/non-appr eciating exchange rate has become an objective in itself. The sacrific e of monetary independence resulting from large intervention pursued w ith a view to preventing significant real appreciation has brought to the fore the government's commitment to a sustainable level of current account deficit. But the conduct of exchange rate policy - whether to use the exchange rate as an instrument or a target - has turned incre asingly complex. Consistently preventing the exchange rate from settli ng at levels justified by market forces may emerge as a major stumblin g block in furthering the process of liberalisation of capital account transactions. This paper is an attempt to place in proper perspective the various issues relating to 'target' and 'instrument' for the exte rnal sector while focusing on the relevant strategic policy options th at would be available to the country as it integrates further with the international financial system.