Financial Daily from THE HINDU group of publications
Friday, Apr 23, 2004
Money & Banking - Insight
Strong rupee could be a boon
S. D. Naik
The reasons for the appreciating rupee are well known and have been discussed by economists and analysts extensively. Basically the exchange rate of the rupee is a function of demand and supply of foreign currency assets. The pace of accretion of foreign exchange reserves has witnessed a significant momentum. Over the past 12 months, the country's foreign exchange reserves have increased by a staggering $37 billion to cross $112 billion by April 2. This is far in excess of the total FDI inflows into the country over the past decade.
Of late, the capital inflows have been robust because of the increased inflows of NRI deposits, foreign portfolio investments and external commercial borrowings of Indian companies. In addition, apart from the booming software exports, pharmaceuticals, automobiles, auto components, steel, and quite a few other manufacturing sectors have been doing well on the export front.
Also, FIIs have been investing in the Indian stock market on a much bigger scale because of the improved fundamentals of the economy. They also invested heavily in the recent IPOs of Indian PSUs; in the ONGC IPO alone, they poured in a billion dollars within a short span of two weeks.
The Reserve Bank of India's exchange rate management over the past two years has been commendable. In order to keep the appreciation of the rupee within desirable limits, it has been routinely buying up dollars and mopping up the resulting liquidity by selling government securities.
But the flood of dollar inflows has become so huge that the RBI is now running short of government paper. The stock of government paper with the RBI came down from around Rs 140,000 crore in January 2002 to just around Rs 25,000 crore by mid-March 2004.
Realising the limits of its traditional rupee sterilisation strategy, the RBI has now come up with the idea of floating Rs 60,000 crore worth of market stabilisation bonds, the proceeds from which would be frozen in an escrow account. Even this scheme has its limitations and it is time the RBI, in consultation with the Central Government, examined better options to handle the dollar deluge that is expected to continue this fiscal.
First, while the RBI should continue to keep a watch on the exchange rate of the rupee and use selective interventions to minimise speculative movements, it need not be unduly concerned over the rising rupee. The concern needs to be tempered with the fact that all the major Asian as well as European currencies have also been rising against the US dollar.
Between April 1, 2002 and mid-April 2004, while the rupee rose 10.7 per cent against the US dollar, the Thai baht went up by over 10 per cent, the Korean won by 13.5 per cent, the Indonesian rupaiah by 11.7 per cent and the Japanese yen by 20.4 per cent.
Over the same period, the British pound rose by 21.4 per cent and the euro by a staggering 27.1 per cent.
Thus the appreciation of the rupee over this period was largely on account of the weakening dollar against most other currencies of the world.
It is only during the current calendar year that the rupee has appreciated marginally against some other currencies, such as the pound sterling, yen and the euro, representing a small recovery of the ground lost over the past two years.
Not surprisingly, the recent appreciation of the rupee against the dollar has not had any adverse impact on the country's export performance. India's exports registered a robust growth of 35 per cent in dollar terms in February 2004.
Import growth in the same month was much higher, at 44.5 per cent, reflecting a pick-up in investment activity after a long gap. Cumulative exports from April to February 2003-04 registered a growth of 14.75 per cent while the import growth over the same period was 26.33 per cent.
There was a time when our export growth had to be supported by a depreciating rupee. It is no longer so. Thanks to the opening up of the economy, most Indian companies have restructured their operations, tried to induct new technologies, shed excess flab, and reduced working capital requirements through better inventory management to take on global competition.
Also, their interest costs have gone down significantly with the phased reduction in interest rates. Hence India Inc is not unduly worried about the appreciation of the rupee against the dollar.
Mr Anil Ambani, Vice Chairman, Reliance Industries, has said his company is not worried about the appreciating rupee. Reliance Industries ended the last fiscal with a 30 per cent growth in exports and has projected export growth for the current fiscal at 25 per cent.
Such IT companies as Infosys, Wipro, TCS and Satyam have come out with shining results for 2003-04, both in terms of export growth and profit margins, dispelling the fears about the appreciating rupee affecting their performance.
Evidently, most IT companies and software exporters have been able to take care of the rupee appreciation in their billings to foreign clients. The experience of major exporters also suggests that when the domestic currency depreciates, the importers bargain for lower prices.
Moreover, exchange rate is only one of the variables influencing the export performance of a country. The other equally important considerations are quality of products, delivery schedules and brand image.
True, with the appreciating rupee, the margins of some of India's traditional exporters are likely to be squeezed. These include textiles, leather and leather products, and agro products. However, in other products such as automobiles, engineering goods, and gems and jewellery, where the import-intensity is fairly high, the strong rupee will not have any adverse effect.
As for the overall foreign trade, the benefits of a strong rupee will outweigh the disadvantages. This is because the total value of our imports is more than that of our exports. The stronger rupee has made imports cheaper.
In particular, the recent appreciation of the rupee has softened the impact of the sharp rise in international crude oil prices in rupee terms considering India's substantial dependence on oil imports.
A rising rupee is also expected to attract more foreign direct investment to India apart from keeping inflation and interest rates down. This should help the manufacturing sector to maintain the tempo of new investments and productivity improvements.
Against this backdrop, the RBI seems to have decided not to intervene actively to stem the rise of the rupee, at least for some time, and to allow it to appreciate moderately. Incidentally, the BJP also appears to favour a strong rupee, going by the Finance Minister, Mr Jaswant Singh's recent statement: "A strong rupee has relationships with inflation management and currency flows... so the party remains committed to a manageable, but strong, currency rate."
A relatively strong rupee can really become a boon provided the Government initiates measures to make use of the bulging foreign exchange reserves to trigger an investment boom in the economy.
After a virtual investment famine of five long years, there are now clear signs of a pick up in corporate investments. It is thus the right time to provide the much-needed thrust to investment activity if the Government is really keen on sustaining the GDP growth rate of around 8 per cent in the coming years.
What the country needs today is large-scale capital investment involving imports of capital goods. A sensible suggestion made by some economists and also the editorial column of this paper (April 3, 2004) deserves serious consideration by the Government.
Since many large Indian companies now prefer to raise external commercial loans because of low interest rates, it is suggested that the RBI should think of allowing banks to buy dollars from the market and offer dollar-to-dollar loans to corporates at Libor-related rates.
This will encourage more companies to go for dollar loans from Indian banks rather than going through the laborious process of going for ECBs. Such a facility will particularly help medium-scale companies and export-oriented units. In fact, exporters have been clamouring for such a facility for quite sometime.
Though as of now there is no mechanism for transferring RBI-owned forex to banks, it should not be difficult for the authorities to put in place such a mechanism.
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