The Hindu Business Line : Rupee: Trade weak, capital strong

Should the rupee be allowed to appreciate at this rate? It has moved up from a low of Rs 49 to around Rs 40 in just a couple of years. The dollar has fallen 18 per cent. Is it a good or bad thing?

The stock arguments for the two sides are aplenty. The anti-strength camp argues that, at these levels, exports will be crippled. Few exporters can take a hit of the order of 20 per cent in their prices without serious damage to their profits or profits turning into losses.

This is likely to be true of the vast majority of ‘commodity’ (in the sense of unbranded) products or subcontract type exports, which are no more than labour cost arbitrage operations.

Given its high value addition, software is possibly relatively cushioned from rupee appreciation.

Relying on theory

The ‘let the rupee find its own level’ group relies on high theory. Foreign investment is a given, essential to accelerate growth.

India, with its booming economy, is (fortunately) one of the most attractive investment destinations in the world. If offshore capital flows drive up the currency, so be it. Do not intervene to stop currency appreciation. You will only flood the market with rupees. Besides, mopping up surplus liquidity has fiscal costs, apart from the low yields on the (unwanted) additions to forex reserves. A significant beneficial side effect, according to these worthies, is lower inflation, as the lower dollar translates to cheaper imports.

Is it a case of putting the cart before the horse? Should trade or capital drive the exchange rate?

India is running a current account deficit (although the last quarter saw a small surplus) and, in the natural order of things, should see a weaker currency. But such is the magnitude and power of portfolio flows that they simply overwhelm the trade effect.

That our reserves are the counterpart of investments and borrowings is confirmed by the latest RBI data on external assets and liabilities, which show that our forex balance sheet is net worth negative, i.e., liabilities exceed assets. Our currency’s strength is therefore, artificial. The absurdity becomes all the more evident in contrast to China’s vast trade surplus ($26+ billion last month alone), forex reserves of $1.13 trillion, lower interest rates, lower inflation and (yes, hard to believe but true) lower currency – the dollar is down just 7 per cent against the yuan in the last two years.

So whom are we fooling? Foreign capital is coming into infrastructure – building, job-creating and export-oriented projects, but that is far surpassed by the flows into stocks, bonds and real estate (and disguised real estate ventures like SEZs).

We are fighting a losing exchange rate battle because of investment flows that do not add sinews or value to the economy.

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