The Hindu Business Line : Preserving rupee profitability

The troubles of many exporters are not a result of the volatility of the rupee but the unfavourably high-cost structures. Exports are viable only when foreign exchange earnings get converted into more and more rupees. To improve rupee viability and preserve profits, exporters need to become efficient and productive and bring down aggregate rupee costs, says G. RAMACHANDRAN.

India’s exporters have relied on a weakening rupee to show progress and profits. Their quarterly profits and organisational profitability kept rising in proportion to the weakening of the rupee orchestrated by the Reserve Bank of India (RBI). They became glittering stars.

The stars are now shocked since the RBI has allowed the rupee to strengthen. Their tailwinds have become headwinds. Export earnings in foreign exchange — especially if they are in US dollars — will produce fewer rupees when the dollar weakens. This erodes the rupee profitability of exports when rupee costs remain stubbornly high. It is worse when rupee costs rise.

India’s exporters have unfavourably high-cost structures. But they have sublimated this problem. They claim that India’s competitiveness has been eroded by the strong rupee. But it would be absurd to think that a weak rupee would make India competitive and its costs supple.

Twin inefficiencies

India’ export economy has a rupee cost structure that it can afford to pay for only when the rupee is weak. Exports are viable only when foreign exchange earnings get converted into more and more rupees.

Aggregate costs are a sum of the product of quantities of inputs multiplied by their purchase prices. First, total costs are high because there is input inefficiency.

Exporters need more inputs than other competing economies to produce the same output. Second, total costs are high because there is procurement inefficiency. Exporters pay more for inputs than their rivals.

Exporters face both input and procurement inefficiency. They are both victims and causes of these inefficiencies.

To gloss over these, they need big rupee revenues, which do not come from rising physical output. They have hitherto come with help from the RBI. The steady weakening of the rupee by the RBI has produced big rupee revenues.

Not by hedging

The troubles of many exporters are not a result of the volatility of the rupee. Their cost-structure is their big problem. Poor viability will not be resolved by hedging. There would be no volatility if the RBI held firm at Rs 41 per dollar. The stable rupee would yet sink numerous exporters. Poor viability will be resolved only when adverse cost structures are altered vigorously, with a shake-up.

Consider an inefficient exporter. It requires a breakeven exchange rate of Rs 45 per dollar to show profit. It will dazzle at a rate above Rs 45. It will fizzle at any exchange rate below Rs 45. Its poor productivity will show up. Now suppose the rupee is volatile. This could be because the dollar is volatile. The mean exchange rate is Rs 41 per dollar; the range is Rs 2 on each side of the mean. So, the dollar will trade between Rs 39 and Rs 43. The inefficient exporter will not be profitable at Rs 43. It will make very big losses at Rs 39 per dollar.

Now consider using a currency forward contract. The forward contract locks in the exporter’s conversion of dollar revenues into rupee revenues at Rs 41, the market’s forward price per dollar. The market will surely not buy the exporter’s dollars at Rs 45. But the hedge at Rs 41 will be wholly ineffective.

The exporter will be in serious trouble despite the perfect hedge. The problem of viability will be solved only when the exporter’s breakeven moves down to Rs 41 per dollar. By contrast, an efficient exporter that is viable at Rs 41 per dollar can take advantage of the hedge.

It would cut its downside if the rupee strengthened to Rs 39. Currency hedging offers no protection against inefficiency and poor productivity.

Aggregate rupee costs

Inefficiency and poor productivity are outright dangers. They are not risks. They corrode profits and push aggregate costs up with certainty. So, to improve rupee viability and preserve profits, exporters need to become efficient and productive. They have to bring down aggregate rupee costs.

Aggregate costs have nine principal components. Five components are specific to the firm and to their suppliers. They pertain to materials, energy, human capital, facilities and managers. Technological costs — the sixth component — are specific to the firm and its alliances with suppliers, inventors and innovators.

The seventh — cost of capital — is driven by the firm and its alliances with banks and financial markets. The eighth and ninth components are taxes and the cost of operating as an exporter. Good governance produces lower taxes.

Good governance raises tax productivity by making available superior human, social and business infrastructure even if tax rates are high.

Good governance lowers the costs of operations; it lowers the aggregate costs of doing business.

Attack the big costs

India’s exporters have serious problems with seven of the nine components. Their comfort zone comprises only two costs: Taxes and cost of capital, in that order. Of the seven components that pose problems, only one — cost of operating as an exporter in an economy — is amenable to action by government. The remaining six components require solutions from within the exporting firm. India’s exporters will have to come to terms with the adversely rigid and unacceptably high costs. They are responsible for six of the nine components of costs. At least three are amenable to vigorous action aimed at promoting and preserving their rupee profitability. These three are human capital costs, facilities’ costs and managerial costs.

Most exporters in India earn their revenues in US dollars. First, they sell their goods and services to importers in the US. Second, they invoice their exports in US dollars even when they export to a firm outside the US.

So, exporters should construct their costs with the dollar and not with the rupee. First, employees and managers of exporting firms will be paid implicitly in dollars. The cost to the company will be in dollars. But the payout will be in rupees, and at the prevailing exchange rates. If the dollar weakens, the dollar costs of employees and managers will be paid out in rupees at, say, Rs 39. If the dollar strengthens, the dollar costs of employees and managers will be paid out in rupees at, say, Rs 43. Second, this method should be extended to facilities. Rentals for offices, logistics for materials and employees, and lease rentals for capital goods will have costs structured in dollars. The payout will be in rupees, and at the prevailing exchange rates.

Indexed correction

The implicit dollar method will significantly preserve the dollar profitability of exporters. It would serve a company such as Cognizant Technology Solutions admirably well. Cognizant is a US company; its financial performance is measured by its stakeholders in dollars.

The implicit dollar method will not fully preserve the rupee profitability of many exporters. Companies such as Infosys Technologies and Satyam Computer Services are Indian. Their financial performance is measured by their principal stakeholders in rupees. What should they do?

First, Infosys and Satyam should implement the implicit dollar method. Second, they should make a further correction for the weakening of the dollar. They may use the US dollar index (USDX) computed by the New York Board of Trade. If the USDX falls by 5 per cent, the rupee payout will be cut by 5 per cent. If the USDX rises by 5 per cent, the rupee payout will also rise by 5 per cent. India’s exporters, and their shareholders, managers, employees and suppliers will hate the implicit and indexed dollar method. Their ‘take’ will fall when the rupee strengthens. That is the intended objective.

To escape from the embarrassment of earning less, they have to become more productive. They have to tell government why and how India could become more productive.

(The author is a financial analyst. Feedback may be sent to indiagrow@yahoo.com and pari@thehindu.co.in)

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