A V Rajwade: The economics of trade

We are far away from a competitive exchange rate, which is essential to recapture the domestic market for manufactured goods and commodities

The other day, Finance Minister Arun Jaitley, perhaps concerned about the fall in exports month after month, and that too, by significant percentages, asked exporters to produce quality products at competitive prices. To quote him: "The world wants to buy good products, it wants to buy cheaper products and therefore you have to think ahead of the others, manufacture products which are cost and quality competitive." Will such exhortations and platitudes do the trick?

The only help the government has given to exporters recently is an annual interest subvention of the order of Rs 2,500 crore. By my back-of-the-envelope calculations, this works out to less than 10 paisa per dollar. Such munificence will do little to improve the economics of exports: even after the last few days of fall, the rupee remains significantly overvalued and the subvention is unlikely to make any difference, particularly when global economic growth and demand are slow. Actually, there is considerable scope for recapturing the domestic market for manufactured goods and commodities from imports, but this will need a competitive exchange rate, from which we are far away.

In my article last week, I had commented on two factors that have led currencies of many emerging economies to fall sharply: fall in commodity prices have affected commodity exporters, while capital flight and reversal of carry trades seem to have impacted many others. The rupee's fall last week is nowhere near the depreciation of several other emerging economies. Commenting on India's external account, The Economist (November 14 issue) remarked: "The current account has moved closer to balance, in part because of low oil prices but also because of the prompt action taken after concerns about capital starting to leave emerging markets sparked a mini-crisis (the so-called "taper tantrum") in 2013." I agree with the first reason, but it is absurd to argue that prompt action to stem capital outflows helped reduce the current account deficit!

In fact, given the Reserve Bank of India's current policy stance on the exchange rate, capital outflows may well be the only way to correct the external value of the rupee. Surely, the proximate cause for the recent fall of the rupee has been portfolio capital outflows of the order of $ 1.5 billion in November. What about the future? Could such outflows continue, or even accelerate, particularly after the expected rise in US dollar interest rates? A few weeks ago, while discussing the issue with a major fund manager, I made the point that we might be more immune to capital outflows and the threat to financial stability they could pose than several other emerging economies already afflicted by the disease, at least partly because of the TINA (there is no alternative) factor: where else will the funds go? (The Chinese market crashed five per cent last Friday.) But I also cautioned that I would quantify the probability of this scenario as no higher than, say, a 55/45 chance.

There are several reasons for the caution. First, as Geraldine Sundstrom of Pacific Investment Management Co, one of the largest global fund managers, recently wrote in a report: "Foreign currency exposure is no longer a simple numeraire that can be hedged away or ignored… Foreign exchange considerations will weigh disproportionately on investment and opportunities." And financial markets are well-known for feedback loops - capital outflows leading to currency fall leading to further outflows ….

The second reason is that, in effect, we have become a "Ponzi" borrower in our external balance sheet, with liabilities far in excess of assets. In a recent article in Business Standard, "Euro zone's Minsky conundrum" (November 27), Daniel Gros defined "Ponzi" borrowers as "those who can service their debt only with new debt". Given the quantity of portfolio investment outstanding, if there are significant outflows, the central bank will find it increasingly difficult to support the rupee by selling dollars from the reserves, as it seems to have done last week.

The third factor that could weigh at some point of time is that our stock market is one of the most expensive ones globally in terms of the price-earnings ratio and recent corporate results suggest that profitability is still under pressure. Particularly hard hit are producers of basic commodities like steel and aluminium: they have been hampered by both the sharp fall in commodity prices globally, and the overvalued currency.

But surely there are better ways than capital outflows to correct the exchange rate.

The author is chairman, A V Rajwade & Co Pvt Ltd;
avrajwade@gmail.com