India seems to be the odd man out. At a time when global powers are lined up against each other over exchange rate management and the threat of competitive devaluation looms over everyone, India seems happy to let the rupee rise. This is even as exports are sluggish, a high negative current account balance persists, and foreign direct investment (FDI) is trailing portfolio investment in the current year in reversal of the earlier pattern. What gives?
The worrisome way of looking at all this is to identify a holy cow as the root cause. Nothing must be done to impede capital flows into the stock market which is getting on to a bull run of sorts. Middle class India has been waiting for this for two years now and there is no question of spoiling the party when it is just about to warm up by stemming the inflow of portfolio investment. Not just common folks, the big and the powerful with alternative resources will not have their round-tripping via the stock market stopped. So, no border restrictions, no Tobin tax a la Brazil. The short-term capital inflow continues unchecked, taking the rupee up and turning the tables against buoyant export growth.
The positive way of looking at the scenario is to argue that export sluggishness is a result of global trade not picking up as consumption trends in developed economies remain weak. According to the IMF (World Economic Outlook), global trade in volume terms is likely to rebound this year after falling last year, but is projected to grow at an average rate of 6.8 per cent over 2012-15, which will be less than the average 7 per cent achieved during 2000-07. As for the current account deficit, a fast-growing economy powered by high investment expenditure will have a keen appetite for import of plant and machinery which will lead to a sizeable current account deficit. The dissonance between FDI and portfolio investment also need not be considered a wholly negative development as the latter need not necessarily create an asset bubble. Corporate earnings are doing well, helping keep in check price-earnings ratios. Plus, anchor investors in public issues end up financing new capital assets.
Thus, while an appreciating rupee may not be doing the damage that it is popularly supposed to be, it can even be doing some good via the impact on inflation. Global commodity prices, on their way up once again, will sharply impact core (non-food and non-energy) inflation during a period of high industrial growth. Since bringing down inflation while sustaining rapid growth is the key task ahead and agricultural prices remain stubbornly high despite a good monsoon, a strong rupee that keeps raw material import costs down is a great help.
There is yet another reason why clever policy-makers may be secretly happy to live with a robustly valued rupee. Indian tariff rates remain high and should be brought down progressively. Bringing down nominal tariff rates is unpopular with domestic industry. It is so much simpler to let the job be done via creeping currency appreciation. Greater import competition for domestic industry does wonders to a country’s competitiveness over time. The appreciation of the rupee since August, assuming a median import tariff of 10 per cent, has brought down the landed cost of imports by 6 per cent. Being able to stand up to cheaper imports is the obverse of being able to competitively export. So that loops back to export performance where we began.
There are a couple of recent developments that go against this line of reasoning. Recent industrial growth rate figures show a decline largely as a result of poor performance by capital goods. This and a declining order book position do not portend well for investment expenditure which has been a driver of high growth. Faltering growth and appreciating rupee do not go well together. But neither the private nor the public sector currently appears reluctant to invest. Business confidence is at a high and there is no resource crunch for public investment. We may eventually see imports matching a lot of investment expenditure but that will only point to the need to address the competitiveness of the domestic machine-building sector. If Bhel’s power plants cannot compete with Chinese equipment in price, then they must at least be clearly superior in quality.
The foremost agenda for policy-makers is to bring down inflation which is largely the result of high food prices. An appreciating rupee is not a contributing villain. In fact, cheap imported edible oils and pulses help contain food prices. Export competitiveness is indeed a priority but a favourable exchange rate is more of a quick fix. Neither auto components nor software exports seem to be suffering from an adverse exchange rate. Apparel exports are, but that is because western demand for higher-end garments (India’s niche) is yet to pick up and a lot of Indian garment factories are uneconomical in size, a hangover from the days when factories were kept small so as to qualify for being small scale. Export competitiveness is a long, hard-fought battle, won industry by industry, cluster by cluster. Auto components (Deming prize), software (CMM Level Five certification) and pharmaceuticals (FDA certified facilities) all score on quality.
The current growth-induced tax buoyancy and disinvestment inflows offer the government a golden opportunity to improve the fiscal balance which is vital for achieving price stability. Once that is achieved, the rupee can be left to find its own level. The benefits of doing so outweigh those from keeping the rupee cheap.