May 6, 2013 Leave a comment
The term “Dutch disease” originates from a crisis in the Netherlands in the 1960s that resulted from discoveries of vast natural gas deposits in the North Sea. The new found wealth caused the Dutch guilder to rise, making exports of all non-oil products less competitive on the world market.Today the term is used in the context of exchange rates,to refer to the negative consequences arising from large increases in a country’s foreign currency inflows including – foreign direct investment, foreign indirect investment,foreign aid etc in addition to the ill effects on non-resource industries a by the increase in wealth generated by the resource-based industries.
Dutch Disease has two main effects:
1. A decrease in the price competitiveness, and thus the export, of the affected country’s manufactured goods
2. An increase in imports
RBI Governor D Subbarao used the term to explain the dilemma he faces:
Between 2002 and 2007, India found itself in a situation where it had to sterilise foreign currency inflows and raise rates because of tight liquidity, which resulted in further inflows. This trend was arrested only after the global financial meltdown of 2008.Similarly if he intervenes in the forex market now and sterilises the liquidity arising out of foreign capital inflows, then interest rates would rise because the inflows are sterilised or mopped up through the issue of bonds, and draining liquidity would result in interest rates firming up, which could attract even more flows.