The Hindu Business Line : Back to the thirties

With the US Federal Reserve board announcing a 50-basis-point-cut in benchmark rates and setting off expectations in India of strong foreign institutional investment and foreign direct investment flows, the rupee has breached the Rs 40 mark, hitting a nine-year high against the dollar. The exporting community is bound to spin into another round of agony over the impact of a weakening dollar on its earnings, but it should not bet on helpful interventions from the Reserve B ank of India, whose concerns are more basic. With inflation still riding high and oil prices firming, the central bank may calibrate its play in the currency markets to keep the dollar at around the Rs 40 level. Any stout defence of the dollar does end up unduly increasing money supply in the economy and the pressure on inflation; and for exporters a modest intervention may not be enough. The equity market has been fuelled all of last month by domestic institutional players. In the coming weeks, the FIIs will come back in full force and the exchange rate will come under pressure yet again.

From a policy viewpoint, this is a good time to convince exporters that any government compensation for drops in earnings on account of rising exchange rates can, at best, be temporary. Two months ago, the Textile Ministry put it out that the Prime Minister would be petitioned for relief, including getting the RBI to intervene in the forex market. But at this point, and perhaps for the medium term — in fact, so long as capital flows continue to keep the real economy and the stock market healthy with funds — the RBI will have to balance the interests of exporters, who want a cheap rupee, with those of the economy that requires cheaper imports of food-grains and oil; in short, lower costs all round. Exporters will have to learn to live with a strong rupee or, in general, exchange rate swings. In the 1990s, the rupee was allowed to depreciate more than 250 times against the dollar; with greater integration into financial markets, such a slide can be sustained only by closing the foreign investment tap or by RBI buying dollars, creating unmanageable levels of liquidity and, therefore, inflation.

The writing on the wall is clear: exporters must re-locate their competitive advantages in what one infotech practitioner calls the Third Wave approach, in which exporters move away from being component suppliers, or the First Wave, through contract manufacturing, the Second Wave, to marketing one’s own brands — the Third Wave. In this wave, exporters will have to create services and products that can command premium, value-based prices, thereby mitigating any adverse change in the exchange rate. A rising rupee may actually persuade exporters to build advantages for the long-term.

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