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The buck stops here

It is in the interest of exports and the gross domestic product that the present over-valuation of the rupee is corrected, writes KK Birla.

india Updated: Jan 21, 2008 21:13 IST
KK Birla

The exchange rate (ER) is an important policy instrument that affects the economy of a country. During its development phase, Japan, for instance, used the ER to promote exports and improve its economic growth. China has for some time started using the ER policy to improve its economic conditions. In India’s case, when the economy had touched rock bottom in July 1991, PV Narasimha Rao, the then Prime Minister, appointed Manmohan Singh as the Finance Minister to revive the economy.

One drastic step that Singh took was to devalue the rupee by 20 per cent. Regarding the rupee, it is not a fully convertible currency. The RBI does intervene from time to time to ensure that the ER is right. That stability of the rupee has been seriously disturbed in the last one year. Since September 2006, when the dollar exchanged for Rs 46.10, the rupee has been consistently hardening. The dollar went on falling and by March 2007, the ER was Rs 44 to a dollar. The fall of the dollar continued and in April 2007, the exchange rate went down to Rs 40 to a dollar. Thus in just eight months — ending April 2007 — the rupee had taken a big jump and appreciated against the dollar by 9 per cent.

Of particular interest is the rupee-yuan exchange rate. Against the rupee’s appreciation of over 9 per cent by March-April 2007, the yuan during the same period appreciated a mere 2 per cent as a result of China’s intervention. As a result, in international markets China gained a 7 per cent advantage over India.

The appreciation of the rupee was due to the near absence of the RBI in the currency market to prevent the rupee from hardening. In fact, the RBI closed its eyes to the rise of the rupee. Its main aim was to keep inflation in check. The RBI, therefore, completely ignored the hardening of the rupee that led to loss of market of indigenous industries and increased unemployment.

Foreign capital comes to India from four sources: a) foreign institutional investors (FIIs) who buy shares of Indian companies; b) foreign direct investment (FDI); c) non-resident Indian (NRI) deposits, which are done to take advantage of the higher interest rate in India; and d) by Indian companies borrowing abroad — external commercial borrowings (ECBs) — to benefit from the low rate of interest prevailing in international financial markets. In 2006-07, the amount of ECBs was $ 16 billion. With a high rate of interest prevailing in India, ECBs make our industrial units more competitive.

The excessive exposure of the rupee to market forces resulted in the hardening of the rupee very significantly. The loss of exports was heavy in respect of textiles, leather goods and sports goods etc. Information technology and IT-related industries like BPOs have also been adversely affected.

A Federation of Indian Chambers of Commerce and Industry (Ficci) survey brought out that our export turnover was down by 11-16 per cent in chemicals, 10-17 per cent in processed food and agro-products, 20-50 per cent in readymade garments and textiles, 25 per cent in electronics and electrical items, and 50 per cent in machinery. Obviously, it would not be possible to achieve the export target of $ 160 billion for 2007-08 set by the Ministry of Commerce. The figures may come down by 8-10 per cent. This will be a big setback to the economy.

About 11 per cent of the industrial production of the country finds markets abroad. If export growth slows down, industrial growth will also slide. A 10 per cent reduction in export growth will mean a 1 per cent reduction in the industrial growth.

The strengthening of the rupee has already caused the unemployment of 200,000 people, as per official figures but about 400,000 people, according to trade and industry. If things don’t improve, this figure will further shoot up. The countries that have gained most from the decline in our exports are China, Pakistan, Bangladesh, Vietnam and Indonesia.

Commerce Minister Kamal Nath has no doubt appreciated the problem created by the over-valued rupee and higher interest rates and initiated measures to alleviate the hardships. The Duty Drawback Rates were revised upwards (by 10-40 per cent) for cotton yarn, fabrics, made-ups, carpets, garments, leather products, handicrafts, engineering products, processed agricultural products, marine products, sports goods and toys. The government also lowered the interest rates on post- and pre-shipment credit by 2 per cent. But these steps by the Ministry of Commerce, commendable as they are, are no alternatives to the softening of the rupee.

The Economic Advisory Council (EAC) preferred restrictions on the use of ECBs. The industry is not in favour of restrictions on ECBs as that would lead to higher cost of Indian products. The question to be addressed is: what really is the right rate of exchange? As a rule of thumb, the rupee has to be priced in such a way that exports plus FDIs are equal to imports. But the exchange rate needs to be judged in the context of the impact of the exchange rate on export performance. Considering all the angles, it would appear that the ideal exchange rate should be at Rs 43-44 to the dollar.

If this is achieved, it will revive the industrial climate and prevent unemployment. In this connection, I would like to look at the suggestions of economist and Secretary General, Ficci, Amit Mitra.
*His first suggestion emanates from the policy being followed by Singapore and which has also been adopted by China. The suggestion is to let our massive foreign exchange reserves be used by the Reserve Bank of India (RBI) “to buy equity in internationally reputed firms”. I don’t think this is likely to affect the value of the rupee. But in case the RBI were to make investments in foreign mutual funds, they could certainly get much higher returns on the money so invested, compared to what they are currently earning, along with the added advantage of appreciation in the value of the investments.

* Simultaneously, Mitra says that we should raise the cap on Indian companies investing abroad from the current limit of 300 per cent of net worth to 500 per cent of the net worth immediately. This is a good suggestion and should receive early consideration by the Government of India.

* Side by side, the intervention of the RBI will have a sobering effect on the international market. It is not the quantum of interventions that will count; the very fact that the RBI is alert and has intervened will change the atmosphere.
These measures would ease the pressure on the rupee.

The ad hoc measures taken by the Commerce Ministry have been warmly welcomed by the trade and industry. But that itself is not adequate. The ER policy as enunciated by me would help all the industries and should, therefore, be adopted by the RBI and the Government of India as early as possible. It would, therefore, be in the interest of exports and the GDP that the present over-valuation of the rupee is expeditiously corrected, along with reduction in the interest rates.

(KK Birla is former Member of Parliament, Rajya Sabha and the author of Brushes With History)