The Hindu Business Line : Does strong rupee signal a shift in monetary policy?

BLOOMBERG News carried a story on March 30 that the Reserve Bank of India (RBI) might be allowing the rupee to strengthen to curb nascent inflationary pressures. That is the first serious comment I have read that tries to explain the recent rupee movement in economic terms. It talks of a shift in RBI policy towards using exchange rates as a policy tool instead of interest rates. If so, it is a welcome and very sagacious step.

In the absence of any official communication from the RBI, we are reduced to guessing its intentions. If it is a policy shift, then the country can do with greater transparency from the central bank. Perhaps, their fear is that might open the floodgates for the rupee to strengthen even further.

By taking the upward pressure off interest rates through a large one-off appreciation of the exchange rate is very intelligent considering the delicately poised investment cycle in India. Further, any sharp increase in the interest rate might also be negative for the nascent boom in auto and home finance.

Although some talk of `bubble-like' conditions in home finance, I am sceptical of such doomsday arguments so soon in the cycle. These are secular trends and they have just begun.

Bankers might be going overboard (too liberal) with their loan conditions but I doubt if the households have begun to borrow recklessly. If young workers in their 20 and 30s borrow early to have a home of their own, it is because they enjoy income and confidence levels that their fathers and grandfathers did not even dream of.

The widespread expectation now in the analyst community is that the crude oil price would decline over the summer. It is the consensus view and, as with most consensus views, it is wise to be sceptical of this one too.

Consensus or conventional wisdom has been consistently wrong on crude oil trends in the last several years and there is no reason to suspect that they are about to botch their record!

They once again expect OPEC production discipline to be observed in breach than in practise despite OPEC record over the last two+ years in largely observing their quotas. Hence, if the crude oil price does stay at current levels (above $35 per barrel for WTI) or if it rises, a strong rupee would be a huge advantage for India.

Further, if the global and the US economic recoveries are about to fade and if American corporations continue to face pressure on costs and executives hanker after profits (given that executive compensation remains linked to short-term profit performance), I wonder if the Indian IT or ITES sectors could contemplate rising the dollar prices of their services.

It might appear too risky considering the political backlash that these sectors face already, but if the above oil price scenario materialises (as I expect), it might not be so infeasible after all. Foreign corporations would be under even greater pressure to reduce costs. It is a bit scary at first when we first start flexing our muscles but the sooner we do it, the sooner we would be able to practise it comfortably.

In this regard, the vision document released by the Bharatiya Janata Party declares that the party believes in a responsible fiscal regime marked by modest deficits, low inflation and a steadily strengthening rupee. The reference to a steadily strengthening rupee is interesting. It is a statement of confidence and self-belief.

As a large domestic economy, India does not have to rely on exchange rate competitiveness for export competitiveness. There is tremendous potential for achieving productivity gains offsetting any temporary disadvantage imposed by a strengthening rupee. Productivity is both a firm-level and macro-level issue. Large Indian firms have already demonstrated their ability to cut flab and trim waste. That has resulted in the new found confidence to take on the world and even the talk of creating

Indian MNCs does not seem utopian any more. At the macro-level, Central and State governments must do all in their powers to reduce their discretionary powers (this contradiction is at the heart of the lack of progress in administrative and bureaucratic reforms) and thus reduce transactions costs for the average citizen and firm.

Ever since the Bretton Woods regime ended, the Japanese yen and the German mark appreciated against the dollar except for a brief period between 1983 and 1984. Yet, they remained international export powerhouses.

Productivity and low inflation did the trick. India should be inspired by their examples and a strong rupee fits in rather well with the image and reality of a resurgent India.

(The author is Director, Global Economics and Asset Allocation in Credit Suisse, Singapore. The views are personal. Please address feedback to nageswar@singnet.com.sg)

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