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Sunday, December 16, 2007

Fall and rise of the rupee

A dollar in the 1970s cost Rs 7.50 and for the next three decades the rupee continued to decline. The rupee depreciated to touch Rs 49 to a dollar in mid-2002, and then appreciated till it breached the 40-mark in September 2007.

Recently, the Finance Minister, Mr P. Chidambaram, speaking at the Peterson Institute of International Economics in the US said, “The depreciation in the value of the dollar versus the rupee has thrown up unexpected downside risks and (although) the level of appreciation of the rupee was well beyond comfort levels…that is something we have to live with and our exporters will have to learn to live with it.”

In a relatively free market economy, a currency reflects the inherent strength of the economy and the stronger rupee in many ways reflects this aspect. An exchange rate depends on a number of complex factors — trade deficit, foreign exchange inflows, interest rates, currency reserves, etc.

A balancing act

The Reserve Bank of India would need to control both inflation and foreign investment flows (that is, match inflow with outflow of dollars).

In July, the Government announced an export relief package of Rs 1,400 crore for a number of industries , but trade bodies are asking for more. They want the RBI to intervene to stabilise the exchange rate, at least for the short term. In one of the world’s fastest growing economies, this can be done only to an extent.

Various interest groups want the Government to act in a certain way, but the latter should act in the best interest of the nation.

Where do we stand?

But are we better off with a weaker rupee? A rising currency has both pros and cons — some enterprises gain and others do not. Companies with revenue models that have earnings in dollars but costs in rupees are the worst hit. The IT and BPO sectors have clearly been hit, with profits falling due to lower realisation in rupee term of the billable hours denominated in dollars and salary costs in rupees showing no trend of buckling down.

Other export industries, too, face similar challenges, especially the SME (small and medium enterprise) segment which operates at low margins and employs nearly 20 million people. As the rupee keeps rising, profits of such enterprises evaporate and the prospect of loss of jobs looms large. Outsourcing is based on complex geopolitical factors that come into play in the country exporting jobs.

Every outsourcing or import is potentially a loss of job in the country that imports. Global trade will never happen if countries only protected jobs of people who support export-related activities.

It is now common knowledge that for every job in the IT and ITeS sector, four new jobs are created in other sectors of the economy such as recruitment agency service, airlines, hospitality, etc., which are also called “dollar dependent businesses”. As the margins of the principal fall, the service providers get squeezed harder. The pain of loss of margins gets passed down the line.

Countries make the decision to import or outsource from another country mostly for reasons of lower price. However, a job often goes to a place simply because of the unbeatable combination of price and quality. A pure cost advantage does not last forever. The loss of profits is not solely because of the rupee rising, which is a macroeconomic factor; rising costs of inputs, such as on salaries, take away the cost arbitrage on a more permanent basis.

Indian companies will benefit more through the creation of freight corridors, power reforms and improvements in infrastructure. These would help reduce the overall cost of inputs and make businesses more competitive. But, currently, exporters, in general, looking to the Government to provide relief.

The rupee is rising against the dollar, and the US economy is currently not riding its best phase.

The rupee has, however, not risen significantly against other major currencies. In fact, the euro and the pound have appreciated against the rupee in recent times.

Focussing mainly on the US markets and the dollar is detrimental for Indian businesses in the long run. And like other Asian economies, Indian businesses need to diversify their risks.

Impact of a rising rupee

It depends on where you are. Imports of crude (at 30 per cent of total imports is the biggest item on the import bill), machinery (17.2 per cent of total), electronic goods (8.4 per cent), gold and silver (7.7 per cent), etc., become cheaper.

These are big ticket expenditures for the country and capable of generating huge savings, but do not stir up emotions such as potential job and revenue losses of the export sector and, hence, does not capture popular imagination. Travelling abroad and investments by Indian residents in dollars become more attractive.

IT and other companies in a globally competitive situation have been able to make large acquisitions of US companies and, at the current exchange rates, any drop would entail substantial savings. Tata’s $8 billion acquisition of Corus or Hindalco’s recent $6 billion acquisition of Novellis would have a lower cost of acquisition from an Indian shareholders’ side due to the current exchange rates.

The deputy chairman of the Planning Commission, Dr Montek Singh Ahluwalia, believes that the Reserve Bank of India and the Finance Ministry face a difficult set of choices.

In a recent interview, he said that this is a balancing act that the Reserve Bank and the Finance Ministry have to play. It is a reflection mainly of the trilemma that economists face; you can only have two out of three things.

If you want to have a stable currency, an independent monetary policy and capital account convertibility, you can’t have all three. You have to give up one. This is the classical trilemma and the multiplicity of choices!

As the Indian economy continues to mature and as Indian businesses gain confidence to do business globally, nuances of risks associated with a fluctuating currency have to be better understood and tackled in a holistic way and factored in as only another business risk. In other words, core strength of businesses has to be expanded from just cost-competitiveness.

Meanwhile, let us toast the rising rupee as a symbol of resurgent India.

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