The Hindu Business Line : Weak rupee not the cure-all

Policy-makers want a weaker rupee so that India’s export competitiveness will rise. They do not think that it is normal for the rupee to appreciate as a result of greater foreign exchange inflows into the economy. This absurdity will continue until policy-makers turn their attention to raising productivity of governance and the competitiveness of the aggregate supply chain, says G. RAMACHANDRAN.

It is a pity that many of India’s exporters have chosen to rely on a weak rupee to sustain their competitiveness. They are now deeply disturbed. Their future ‘rupee profitability’ is in jeopardy. They are horrified that the Reserve Bank of India (RBI) has allowed the rupee to strengthen. They are nervous that the RBI may have given up its policy of ‘weakening through intervention’ in the foreign exchange markets.

It is worse that some policy-makers really believe that a strong rupee is a threat to India’s competitiveness. They have come with a set of sops aimed at compensating exporters for the losses stemming from the strong rupee. They do not think that it is normal for the rupee to appreciate as a result of greater foreign exchange inflows into the economy. They have opted to ignore the cause of the rising inflows. There is some naiveté in this.

What they want is a weaker rupee so that India’s export competitiveness will rise. They want more exports to lead to greater foreign exchange inflows. They want these inflows to rise so that India can fund its imports. But the rupee will inevitably strengthen if inflows of foreign exchange exceed outflows. They will then argue that the strong rupee is a threat to India’s competitiveness. There will be more sops. There will have to be.

This absurdity will continue until policy-makers turn their attention to raising productivity of governance and the competitiveness of the aggregate supply chain. Raising the productivity of governance — and not merely of corporate governance — is a prerequisite for raising the productivity of the aggregate supply function and the markets for inputs and output. Earnest effort is required in this direction. Sops postpone such earnestness.

Productivity and competitiveness

Sops are seductive and magical. They have numerous supporters. The reasons are obvious and straightforward. They turn unprofitable exporters profitable. They take away the pressure of having to be the best in the world. Mediocre firms that are not so competitive can turn in big profits because of sops. They can show off their profits without having to work their muscles. No body mocks at rewards that come without effort.

The reasons once again are straightforward. Profitability and competitiveness are not the same. Competitiveness stems from productivity. National competitiveness and economic welfare are determined primarily by productivity in both the traded and non-traded sectors. It is important to emphasise that governance is a non-traded sector.

Productivity is the amount of output produced relative to the amount of resources (human effort, and physical and technological assets) that go into the production. It is quantitative. It does not depend on the monetary value of the output relative to the inputs. Productivity and competitiveness improve when the quantity of output increases relative to the quantity of input. They are the equivalents of the strike rates of batsmen and bowlers.

By contrast, profitability is the value of output relative to the cost of inputs used. Profitability improves when the cost of inputs used is reduced relative to the value of output. Sops are aimed at reducing the cost of inputs without reducing the quantity of inputs. It is no surprise that superficial commentators love sops.

Profitability also improves when the value of output is raised. The weak rupee is aimed at raising the rupee value of output without raising the quantity. It is no surprise once again that the merits of the weak rupee are presented most assertively by those who have no clue about making the Indian economy more productive and more competitive. Worse, they regard the weak rupee as a cure-all for the shortcomings in aggregate competitiveness.

China’s earnestness

While presenting the case for the weak rupee, influential thought leaders often cite China’s example. China has a record of keeping the yuan weak against the US dollar to boost its advantages in global trade. It has accomplished this by pegging — more or less — the yuan to the dollar. But there is little proof that it is dodging the issues pertinent to its aggregate competitiveness. There is significant proof that China has been earnest about its competitiveness.

Its output per employee has risen by over 8.5 per cent annually since 1993 against only 4.6 per cent for India in the same period. The Total Factor Productivity (TFP) has risen at an annual rate of over 4 per cent in China, and by merely 2.3 per cent in India. No one seems to be too concerned about the width of these gaps.

How about Germany?

Raising competitiveness requires that both TFP and output per employee should be raised. But raising profitability requires neither. It is not so demanding. Sops and the weak rupee are the lazy, easy solutions. Profits can be shown off without working the muscles. A profitable firm need not be competitive; there is no compulsion for India’s profitable exporters to pursue competitiveness. It would be enough for them to lobby for sops or for a weaker rupee or both. Profitable exporters propped by these will not make the Indian economy competitive.

By contrast, competitive firms will be profitable. Competitive economies such as Germany’s will have numerous exporters that are profitable even when the euro rises in value against the US dollar. Similarly, most Japanese exporters will stay profitable even if the yen were to rise from 123 per dollar to 105. And, more than 70 per cent of Japan’s exporters will stay out of trouble if it appreciated further to 90 yen per dollar.

Germany’s share of global trade is high despite the rising value of the euro. Its exports jumped by 9 per cent even as the euro appreciated by 8 per cent. German exports now constitute nearly 10 per cent of international trade. In particular, Germany’s share of exports to the newly-industrialised economies is about 31 per cent. That is whopping. It is also ironical.

Economists in the newly industrialised economies have argued for weakening their currencies even as German exports grew despite an appreciating euro. Their case for weakening their currencies appears weak indeed.

The main reason for the greater and rising share of Germany’s exports is its competitiveness. This competitive advantage has resulted from the tough restructuring measures undertaken by Germany’s exporters. Moreover, they have worked hard to overcome the impact of a hike in the rate of value-added tax.

Missing the point, forever

India’s policymakers should pay careful attention to the difference between the profitability and competitiveness of exporters. Rising competitiveness is the result of rising productivity. So, it is frustrating that sops acknowledge India’s shortcomings in productivity and competitiveness but turn a blind eye to the causes of sagging productivity and lagging competitiveness.

But what is of graver concern is that India’s influential thought leaders think that a weak rupee creates more winners and a strong rupee creates numerous losers. There are four problems they dodge. First, they do not explain what competitiveness is. Second, they do not explain why India’s exporters struggle.

Third, they do not explain that exporters flourish at the expense of domestic manufacturers that serve domestic customers. Fourth, they seldom explain how domestic manufacturers too love a weak rupee because it stifles competition from imports.

When the rupee is weak, imported goods are costly. This permits domestic producers to raise their prices up to that point where they are a touch lower than the landed price of imports. So, the ‘establishment’ loves a weak rupee because it is the beneficiary. The weak rupee is like a good drought in India.

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

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