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There have been different degrees of exchange rate disequilibrium in thedeveloping countries during transition or reform periods since the mid 1980s. The levelof the exchange rate and its misalignment can have significant impacts on agriculturalpolicy measures such as Producer Support Estimates (PSEs). In the conventional PSEanalysis, however, the actual (nominal) exchange rates are used. There is generalagreement that the use of actual exchange rates may introduce a bias in the PSEcalculations, and that this bias can be substantial in some cases. But there is lessagreement on the most appropriate alternative.In this study, we utilize various time series techniques to derive estimates of theequilibrium exchange rates in India and China from the 1970s to 2002 as determined byreal economic fundamentals. The relevance and usefulness of the equilibrium exchangerates in the calculation of PSE for the two countries are then discussed. Drawing on thedata sets and analyses developed earlier by Mullen, Orden and Gulati (2005) and Sun(2003), we find that agricultural support levels measured by the PSEs (from 1985-2002for India and from 1995-2001 for China) are sensitive to alternative exchange rateassumptions. Specifically, exchange rate misalignments have either amplified orcounteracted the direct effects from sectoral-specific policies. In India, such indirecteffects are relatively small and mostly dominated by the direct effects. But in China,especially in recent years, the indirect effect from exchange rate misalignment(undervaluation) has been quite substantial.Results from this study also show that the effect of the exchange rate depends onthe relative importance of different PSE components. The increasing share of budgetaryexpenditures in India’s total agricultural support in recent years has resulted in morepronounced exchange rate effects measured by commodity-specific percentage “PSEs”that use the value of production at international prices as the denominator compared tothose measured by commodity-specific percentage Market Price Support (MPS) with the same denominator. For China, the exchange rate effects are more similar between thePSE and the MPS measures because budgetary expenditures have been relatively small.The exchange rate effect when the PSE is “scaled up” from covered commoditiesto an estimate for the total agricultural sector is also demonstrated. Since the commoditycoverage in both countries tends to be incomplete and the scaling-up procedure leads to atotal MPS of greater magnitude, larger exchange rate effects are found in the scaled-upthan the non-scaled-up version of total PSEs. The impact of scaling-up on the indirecteffect is proportional to the share of covered commodities in the total value ofagricultural production.

Keywords: Agricultural policy ; Producer Support Estimates (PSEs) ; Agricultural support ; Agricultural production

Subject(s): Agricultural and Food Policy

International Relations/Trade

Issue Date: 2005-02

Publication Type: Working or Discussion Paper

PURL Identifier:

Total Pages: 102

Series Statement: MTID Discussion Paper


Record appears in: CGIAR > International Food Policy Research Institute (IFPRI) > MTID Discussion Papers

Autor: Cheng, Fuzhi ; Orden, David


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