The opportunities of a stronger rupee

In an appreciating currency regime, exporters benefit from lower import costs.

Our article in this newspaper on November 15 ("A strong rupee hasn't always hit exports") highlighted that firstly, since the turn of the new millennium, net trade in real terms has contributed, contrary to popular belief, positively to economic growth except in the first quarter of the current fiscal. Secondly, the correlation between rupee-dollar rate and the export growth in different sectors has diminished over the last decade. Thirdly, there has been substantial, if not sufficient, improvement in the productivity of some industries, and greater product and market diversification should enable exporters to remain competitive.

A factor that was left out of the discussion in the previous article was the impact of the rising rupee on exporters' costs of production, the point which we discuss here. Just as a dearer rupee makes exports more expensive, it also increases the ability to import cheaper inputs. The average import growth in the last five years has been close to 30 per cent. More recently, non-oil import grew at 35.4 per cent in April-September this year compared to 9.2 per cent during the same period last year: imports have clearly picked up as the currency has depreciated. Recently, imports of consumer durables/non-durables are likely to have increased as consumers prefer cheaper imported products. However, imports of raw material and capital goods, many of which go into exports, have also risen. 
 

IMPORT INTENSITY OF SELECTED INDUSTRIES
Manufactured goods	0.29
Gems and jewellery	0.51
Chemicals and related products	0.45
Textile and textile products	0.13
Petroleum products	0.43
Non-financial services	0.05

EXPORT GROWTH IN APRIL-JUNE 2007 (Y-O-Y %)
Industrial sector	Dollar terms	Rupee terms
Relatively high import-intensive
Petroleum products	26.17	14.41
Gems and jewellery	20.98	9.71
Engineering goods	20.34	9.12
Electronic goods	5.50	-4.33
Chemical and related products	5.31	-4.50
Relatively low import-intensive
Leather and Manufactures	2.39	-7.15
Textiles	-10.37	-18.72
Handicrafts	-43.50	-48.76
Source: DGCIS, Ministry of Commerce

A close indicator of how different export industries gain as a result of a higher rupee is the "raw material intensity of exports". For two sectors (gems & jewellery and chemical products), we could estimate the intensity by estimating export-related sectoral imports as a proportion of exports from the trade data provided by DCGIS. For other sectors we depend on the CMIE data. While this may not be the best indicator, it still serves the purpose. Rupee appreciation is likely to cause three major outcomes on exports:

Highly import-intensive exporting industries are likely to derive advantage of a higher purchasing power as imports become cheaper when the currency appreciates without compromising their profit margin. Niche segments and those such as gems & jewellery, petroleum products and chemical industry exports that account for about 40 per cent of the total exports are examples of such industries. Our estimates suggest these industries have close to 50 per cent import intensity, but for some industries the figure may be even higher. For example, according to the gems & jewellery export promotion board, the import intensity is 70 per cent.

On the contrary, an industry with very low or zero import intensity will not have the cushioning effect of lower input costs. For example, the service industry is estimated to have an import intensity of only 5 per cent. However, on the positive front, the export-oriented service industry does not yet face strong competition in the market. It has experienced rapid productivity growth and is increasingly specialising in high-end service demands that command a premium in the export market. Hence, despite a stronger rupee, the impact on this industry's export growth will be relatively muted.

Commodities with varying degrees of import intensity are likely to have a mixed impact, that is, they have both the advantage of cheaper inputs and the disadvantage of fairly competitive and often labour-intensive exports. The industries that fall in this category have to gear themselves to withstand the pressure of a stronger rupee by increasing their scale of operations and improving efficiency.

Further evidence points to the fact that a decline in import price allows exporters to reduce the export price, thereby aiming at volume growth. We statistically estimated the impact of changes in the unit price index for raw material and capital goods on the unit price index for manufacturing exports for the period 1980-81 to 2005-06. The result suggests that a unit decline in the price of raw material imports leads to a 0.78 unit decline in export price. Similarly, a unit decline in the price of imported capital goods reduces the export prices by 0.50 unit, all else being equal. The existence of a causal link between the import price and export price indices indicates that exporters benefit from lower import costs made possible by currency appreciation.

Finally, let us look at the current fiscal's latest available commodity-wise numbers. Clearly, the export growth is led by import-intensive goods such as petroleum products, engineering goods, electronic goods and gems & jewellery. However, exports of the import-intensive chemical sector grew only 5 per cent in dollar terms. Exports of labour-intensive goods like handicrafts, carpets and textiles have dropped sharply.

Thus, this discussion brings us back to whether a rising rupee is a cause for worry for exporters or not. Clearly, currency appreciation would result in some winners and some losers across industries. The extent to which losers lose out will depend on their import intensity and productivity, among other factors. Given that imported goods are used as inputs in a number of manufactured exports, a rising rupee will help to offset the impact of lower dollar revenues. Although, in the short run, the deceleration of exports may continue, the appreciation would not necessarily influence the trend growth of exports negatively.

Exporters, however, need to recognise the fact that given the strength of the Indian economy, its currency will continue to gain strength in the coming year, however hard the government or RBI try to control it. Exporters across industries would have to adjust to a higher rupee by making their production more cost- and process-efficient. Certain export industries such as leather and textiles will have to increase their ability to be more competitive in the global market by achieving economies of scale and improving productivity. No doubt, these industries are labour- and skill-intensive, making the restructuring more difficult. It is often said that India needs a crisis to reform. It is critical given the extent of human participation in certain export industries that the reforms are undertaken much sooner than that.

The authors are economists at CRISIL Ltd