Accept Rupee Appreciation Gracefully

Accept rupee appreciation gracefully

K. Abraham Varkey

While the rupee's rise has helped some exporters to rein in costs and increase their competitiveness in the global market, in general, profit margins have eroded. Indian importers, borrowers of foreign currency and the consumer have, however, all gained. The clamour for government intervention to depreciate the rupee thus seems overdone, says K. Abraham Varkey.

APPRECIATION is an art, and a fine one at that. Through aeons of human history much thought and effort have been invested in perfecting it. The finely turned compliment, the winner's laurel wreath, the perfect rose, the solitary diamond, the garland of beautiful flowers are all forms of appreciation which have been honed through the centuries.

While appreciation is a fine art, knowing how to accept appreciation gracefully is an even greater art. The angst voiced at the rupee's appreciation in newspaper columns and seminars conducted by industry and exporter bodies seem to fly in the face of the time honoured cultural habit of accepting appreciation gracefully.

Normally, currencies appreciate when the economies are doing well and the rise in their values is a cause for celebration. The high value of the deutsche mark when Germany was the trendsetter for the world economy in the 1960s and the 1970s, the high value of the yen in the 1980s when Japan Inc seemed set to take over the world and the dollar's high value in the later 1990s when the US new economy brooked no competition were sources of immense pride for their respective countries.

An appreciating currency is the natural corollary of a booming economy with rising exports and is normally looked on favourably. The high-decibel lamentation over the rupee's appreciation, therefore, needs closer examination.

Has the rupee really appreciated? Taken over a three-year frame, from June 2000 to September 2003, the conclusion is a firm no. The rupee depreciated by 1.69 per cent against the dollar, by 24.13 per cent against the euro, by 12.19 per cent against the pound, and appreciated by 1.79 per cent against the yen during the period.

Narrowing the period to May 2002, when the rupee hit its low against the dollar, to mid-October, 2003 the result is mixed, with the rupee appreciating by 7.30 per cent against the dollar, and depreciating by 18 per cent against the euro, by 6.12 per cent against the pound and by 7.28 per cent against the yen.

In both periods the rupee appreciated only against one of the major international currencies in which India's foreign trade is mainly denominated. The rupee is now seen to be fairly valued on trade weighted REER terms.

The causes for rupee's appreciation after years of continuous depreciation are readily apparent. The current account surplus for the first time in years (it has since reversed), due to increased merchandise exports and invisibles, has resulted in supplies of foreign currency going up sharply.

The huge FII inflows into financial asset markets (over $3.9 billion net inflows in the first 10 months of this fiscal), and increasing reliance on low cost foreign loans (the RBI has approved ECB borrowings to the tune of $1.7 billion in the April June quarter alone) add to the supply glut, and help power the rupee higher.

The rupee's appreciation is a result of forces of demand and supply operating in the forex markets and involves no cost to the exchequer.

The heartburn on the rupee's appreciation against the dollar is due to the fact that most of India's external trade is invoiced in dollars and any change in the dollar's rupee value has a disproportionate effect on the various stakeholders in the rupee's external value such as importers, exporters, borrowers, lenders and consumers of imported goods.

The differing impact of the changes in the rupee's value on various stakeholders explains the sudden outcry against appreciation. Importers and borrowers in foreign currency are delighted with the rupee's appreciation to the dollar as most imports and external borrowings are denominated in dollars.

The Indian consumer is a big beneficiary too, as costs of a host of imported goods — from petro products to electronic, electrical and consumer items — would be higher but for the rupee's appreciation. The rupee's appreciation is one of the reasons for the current low inflation rate.

The effect of the rupee's appreciation is not marginal as according to the World Bank, imports account for about 16 per cent of India's GDP. Importers, borrowers in foreign currency and the average Indian consumer are the unambiguous gainers from the rupee's appreciation.

Since Indian lenders in foreign currency normally hedge their exposures, the brunt of the negative effects of the rupee's appreciation falls on exporters, giving rise to calls for government action to depreciate the rupee. However, the effect on exporters too is not all negative.

With increasing global integration an ever-increasing proportion of exports consists of imported raw materials and components. This is particularly true of the diamond, high-end textile and engineering industries that use a high proportion of imported goods in their exports.

The rupee's rise has helped these exporters to rein in their costs and increased their competitiveness in the global market place. However, exporters, in general, have seen their profit margins erode as a result of the rupee's unexpected appreciation.

Though exporters have seen their profit margins shrink, exports on the whole do not seem to have been affected seriously the rupee's appreciation. The slowdown in exports in the past few years has been more due to global economic conditions than due to the rupee's rise.

Exports in dollar terms grew by an impressive17.2 per cent in 1999-2000 when the rupee depreciated by 2.90 per cent. For the period 2000-01, when the rupee depreciated by 7.07 per cent, exports grew by a slow 1.7 per cent. In 2001-02, when the rupee depreciated by 4.78 per cent, exports crawled up 1.74 per cent.

The trend continued in 2002-03. Contrary to expectations, however, exports registered their highest growth of 11.06 per cent in the April-June 2003 quarter when the rupee appreciated by a high 2.11 per cent. For the period April-August 2003, for which provisional figures are available, exports grew 8.99 per cent in dollar terms. Available data do not support the claim that the appreciating rupee has affected Indian exports.

Another claim being loudly bruited is that exports have suffered because the currencies of our main Asian competitors have depreciated and but for the rupee's rise exports would have been much higher. This claim too does not hold water.

Since the rupee hit its low in May 2002, it has appreciated by 7.30 per cent, while the Pakistani rupee has appreciated by 3.97 per cent, the Korean won by 8.56 per cent, the Indonesian rupiah by 8.93 per cent and the Thai baht by 7.07 per cent. Only the pegged currencies — the Chinese yuan and the Malaysian ringitt — have remained steady. Against the yuan and the ringitt too it cannot be said that the Indian exports have suffered due to the rupee's appreciation because in the post-Asian crisis period from 1998 to May 2002 these currencies remained steady while the rupee depreciated by about 25 per cent to the dollar.

In this period, when Indian exports should have gained a competitive advantage of 25 per cent compared to Chinese and Malaysian exports, both Chinese exports (by a large margin) and Malaysian exports (by a narrow margin) outperformed India.

Data again do not support the claim that Indian exports would have been much higher had the rupee not appreciated.

Statistics seem to prove that Indian exports have not been affected seriously by the rupee's rise, and Indian importers, borrowers of foreign currency and the Indian consumer have all gained.

The clamour for government intervention to depreciate the rupee seems overdone.

However, as the rupee continues to rise, the demands for intervention are likely to become shriller. An artificially managed depreciation would result in higher cost to Indian importers and to the consumer in exchange for a probable boost to exports.

Much needed public money would go to transferring cash flows from importers and consumers to exporters leading to a misallocation of resources.

Market forces if left unhindered will soon correct the imbalance arising out of the rupees current rise. The inward flow of foreign currency will not continue indefinitely. Loans will have to be repaid and FII investments can reverse.

A dearer rupee will make imports more attractive leading to increased demand for foreign currencies and eventually a fall in the value of the rupee. The start of such a process is already evident. Imports grew by a rapid 22.14 per cent in April-August 2003.

Non-oil imports, made attractive by the rupee's current levels and fuelled by an expanding economy, grew by a high 28.35 per cent in the same period. The markets have already begun the work of correcting the imbalances and given time will settle at a new equilibrium.

Intervening to artificially depreciate the rupee will involve outlay of public funds which can be better used elsewhere. And as data show, this may not result in any appreciable rise in exports as the past slowdown in export growth was determined by global economic conditions and not only by the rupee's value. The rupee's value seems to have but a marginal effect on export performance.

The rupee, with centuries of history behind it, is capable of depreciating with elegance and appreciating with grace. If only we would let it.