AV Rajwade: It's the rupee, stupid! : BS
While many in the government are talking of tax and other sops, it is the value of the rupee that determines
exports.
Last week, when the rupee appreciated to below 46 per dollar, there were reports about the ?sops? expected
to be offered to exporters in the next few days (One has always wondered why any procedural simplification
or other benefits given to exporters are referred to as ?sops?: The dictionary meaning of the word is
?conciliatory bribe, gift or concession?). Incidentally, the series of import duty cuts over the last two decades
have rarely been referred to by the media as ?sops? to importers. These seem to consist of extension of
some schemes (export credit interest rates?), increase in duty drawback rates for exports to ?specific
markets, of specific products, and of specific products to specific markets?! One wonders whether anybody
has quantified the actual benefit of such ?sops? as a percentage of exports. According to my estimate, a 1
per cent cut in export credit interest rates, even if you assume it is honestly passed on to the exporters by
lending banks, improves the margin by just 0.1 per cent of exports! In contrast, the rupee?s appreciation
against the dollar and the inflation differential together mean a loss of competitiveness of as much as 10 per
cent in the current year! ?Sops? are no substitute to a competitive exchange rate! The recent appreciation of
the rupee has had me wondering whether our domestic currency has become a ?commodity currency?:
Media short form for currencies of large commodity exporters ? Australia, for example. (While we do export
one commodity in significant quantities, namely iron ore, we are hardly a major commodity exporter: Indeed,
our import bill for commodities is much larger than export earnings.) These currencies tend to appreciate
when global commodity prices are rising, which is exactly what has happened with the rupee recently. At the
opening rate last Friday morning, the rupee had appreciated about 14 per cent against the dollar since
March 2009. To be sure, most Asian currencies have appreciated against the dollar during the period, but
these countries have surpluses on the current account. Last Thursday, the newly appointed finance minister
of Japan expressed his desire for a weaker yen and hinted at intervention in the market if needed.
One currency which has remained rock steady against the dollar during this period is the Chinese yuan. The
Economic Times reported on January 7 that the ?yuan revaluation move? took the rupee to a 12-week high.
The ?move? is a recommendation by a ?think tank? which, of course, may or may not be accepted by the
authorities. To my mind, it is extremely unlikely that, from a ?big power? perspective, China would make a
change in policy at this stage. In the last couple of months alone, it has been publicly pressured both at the
Apec Summit, and bilaterally by senior EU officials, to change its policy: A change now would clearly create
an impression that it has succumbed to external pressure, an impression the Chinese would be most
reluctant to create. Surely, one reason for our $20-billion bilateral trade deficit with China is the difference in
exchange rate policies?
The reason for the rupee?s appreciation is not so much competitiveness of the domestic economy as capital
inflows. As per the balance of payments data for the first half of the year, published on December 31, the
current account deficit has gone up from $15.8 billion in H1 2008-09 to $18.6 billion ? or, say, 3 per cent of
GDP. The current account deficit has gone up despite a reduction in the merchandise trade deficit, the latter
primarily due to lower oil prices. (These have gone up ever since and analysts expect the price to go up
further as global economy recovers more strongly in the current year.) The surplus on invisibles has dropped
even more sharply, leading to an increase in the current account deficit. One point should not be forgotten:
The deficit is suppressed by the inclusion of inward remittances as part of the current receipts. While this is
the accounting convention, the fact is that, in terms of economic analysis, remittances are more like capital
transfers than current receipts. For analytical purposes, the deficit needs to be regarded as closer to 9 per
cent of GDP, a horrendously large figure. And, an appreciating rupee certainly does not help improve it.
One wonders whether the central bank is looking at an appreciating currency as an anti-inflationary
measure. This has turned out to be a costly and risky course for many countries. Also, capital flow-induced
appreciation is not a sign of strength: It is swelling, not muscle. In a panel discussion, while talking about
capital inflows, the RBI governor said, ?No policy option, including Tobin tax, is off the agenda. In the long
list all this is there. The question is what instruments do we use and when?? So far the only option he seems
to have chosen is rupee appreciation. On this subject, we do need to learn more from our northern
neighbour than our western friends: After all, China is undoubtedly the most successful growth economy
ever. But more on the yuan next week.