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Harder rupee, slower exports

In the past four months the rupee appreciated against the dollar, the euro and the yen making our goods and services costly, writes DH Pai Panandiker.

india Updated: Dec 01, 2006 19:44 IST

In the past four months the rupee appreciated against the dollar, the euro and the yen making our goods and services costly in the major importing countries. What is worse, we would have also lost some export opportunities because our competitors from Asia would have been able to offer better terms because their currencies remained relatively stable.

The rupee appreciation was pretty fast and steep. Since the beginning of August the rupee gained 4.9 per cent against the dollar, 2.5 per cent against the euro and 5.7 per cent against the yen. The appreciation came from the inflow of foreign currency through FIIs for investment in the capital market, foreign direct investment in corporate enterprises, and borrowing by Indian companies overseas. The fall in oil prices also helped to cut down the outflow of foreign currency.

The RBI has been intervening in the currency market whenever there was excess inflow or outflow of foreign currency in order to avoid undesirable movements. But since June the RBI has hesitated to do that possibly because a side effect of intervention is a change in the liquidity in the economy. When the RBI buys foreign currency it pumps in equivalent rupees in the system. The danger of this infusion of liquidity can be a rise in the rate of inflation which has already touched the tolerance limit.

Presently, banks have been under pressure to increase credit for which there is a strong demand from trade, construction and industry. Banks have therefore been selling Government securities in order to make room for credit. The robust increase in bank credit is the principal reason for the excessive expansion of money supply. The RBI may have preferred to let the rupee harden than add further to liquidity.

A hard rupee, however, creates its own problems. Exports face a double disadvantage. The appreciation against the dollar is 4.9 per cent. Add to that inflation at 5.4 (WPI) per cent and importers abroad would find Indian goods costly by 10.3 per cent. Of course there is inflation in the US too. Taking that into account, rupee appreciation in real terms would be 9 per cent..

Contrast that with China which is our stiffest competitor. Inflation in China is 1.4 per cent, only 0.1 per cent more than in the US and the yuan has appreciated a mere 1.7 per cent since August. As such Chinese exporters have 7.5 per cent advantage over us in the US market. Similarly, Malaysia would have 2.8 per cent advantage and Thailand 3.5 per cent. The rupee has appreciated far too much and it was necessary for the RBI to intervene in the currency market and neutralize liquidity through other means.

The danger of the hard rupee is that our export growth will slow down. Already it dropped to 11 per cent in October from the 26 per cent bench mark. It is necessary for the rupee to keep pace with the yuan if the export target for the current year is to be achieved.

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