The Great Indian Rupee Trick

Early this month, the rupee touched a historic low at 39.30 to a dollar fuelling speculation of an imminent devaluation. In fact, the depreciation of the rupee against dollar has kicked off a volley of conflicting opinions on the right external value of the rupee. It is a matter of time before de facto devaluation becomes de jure. The question is: will it be good for the economy at this juncture?

There is no doubt that the overvalued rupee needs a correction. This sounds plausible only as a reaction to the spate of South-east Asian currency devaluation ranging from 10 to 40 per cent. But to press for an outright devaluation to save exports on competitive ground is a bit flighty. This is because there is no strong evidence to support the assumption that devaluation leads to a rise in exports ipso facto. It does help a rise in export earnings in the short run but proves unproductive in the medium and long run. The fact is investment-led growth is necessary at this stage to ensure steady long-term growth.

 

At this juncture, with political uncertainty and the fear of deficit rising again, what is needed is confidence-boosting measures for domestic as well as international investors. Devaluation is just the wrong remedy for this. The RBIs decision to allow the rupee to take its own course within 5 per cent of either side of 38.40 seems rational. This step allows the market forces their play besides sending out the signal that the RBI will not allow speculative forces to play ducks and drakes with the market. This, again, is a confidence-boosting sentiment.

Sudhir Mulji rightly observes that: If the steady fall in rupee leads to erosion in confidence, all that will happen is that gold imports will go up by leaps and bounds and everyone will make arrangements to keep money abroad. We shall only encourage exports to fritter away the proceeds in useless imports. The experience of the mid-eighties when the country wasted a lot of foreign exchange on import of consumer durables supports this observation.

Incidentally, the recent crisis exposes two chinks in the armour: the first relates to the so-called comfortable forex reserves and the second, to capital account convertibility. Both look suspect. Yet the recent slowdown in export growth seems to lend some credence to the fear of exporters that unless the rupee is devalued, exports may suffer further. Currency adjustment is only part of the problem.

As Jeeban Mukhopadhyaya, an economist, says: Exports have to stand on their own in terms of competitiveness in quality, acceptability in terms of price and quantity in the rest of the world and strict observance of delivery schedules. The increase in export has much to do with fundamental factors than mere currency devaluation. It is pertinent to note that in the past three decades or so our share of world exports has been around 0.5 per cent.

The reason, he says, is simple. We have never developed a sound export base. Our exports consist of a large number of scattered items. We have not focused on even a dozen items or so with a view to developing them competitively for export market on a long-term basis..

Mukhopadhyaya fears that it is difficult to increase exports under the WTO and non-tariff restrictions. There is also the danger of a sharp rise in import cost following devaluation to nullify gains from exports, he avers.

Most export items are price inelastic. The price elasticity of supply of exports is about 0.7 in the short run and 1.1 in the long run, with over 80 per cent of the long-term effect coming through within one year. The price elasticity of demand for exports is about 1.1 in the short-run and about three in the long run, 80 per cent of the long-run effect coming through within two years.

What does past devaluation show? In 1949, the rupee was devalued by 30.5 per cent raising exports, but the Korean boom played a crucial role. In 1966, the rupee was devalued by 36.5 per cent but this failed to increase export earnings. As Vijay Joshi and I M D Little observe: Exports performed indifferently despite the devaluation. The balance of payments improved after 1966-67 but largely because of the decline in imports. Export value fell in 1966-67 and 1967-68 because of the droughts, increased by 14 per cent in 1968-69 after a good crop year, and then grew only marginally until 1970-71. This points towards a need to strengthen the real productive base and generation of export surplus.

Sunil Bhandare, an economist, observes: There is no mechanism to translate potential surplus into exports. Even after devaluation and rise in export values, there is no guarantee that exporters will get all benefits of exports. Much depends on the bargaining power. The point is that should the devaluation come, we may have to pay heavily in terms of the import bill on account of petro products worsening our deficit position. Imports of petro products account for 24 per cent of total imports. Then there is the fear that every additional one rupee depreciation may add Rs 600-700 crore to the debt-service burden apart from adding to subsidies.

India continues to depend on agriculture-based exports. Jute and cotton manufactures, tea, oilcake, tobacco, and pepper etc account for about 74 per cent of the countrys total exports. Rice accounts for 4.3 per cent of agro-based exports. Their growth depends on volumes and hence the need for a sound production base to sustain growth. It is doubtful if the country has an adequate supply base to cash in on the export demand for these commodities even after devaluation takes place.

It is true that contract-based exports where the exporter receives a mark-up on the costs and value-added exports like diamonds will benefit only marginally from the depreciation. Thus, the export impact of the depreciation (and for that matter, the impending devaluation) might not be as large as the exporters lobby claims it to be, says Neeraj Hatekar, another economist.

In the past 50 years or so, devaluations took place largely because of balance of payments crisis, inflation (above 10 per cent), failure of agriculture and political instability. The current economic scene is marked by low inflation and comfortable reserves position. Current account deficit is at around 1 per cent and does not warrant an extreme step like devaluation.

To quote Joshi and Little again: ... One cannot go far wrong in treating the devaluation package as a non-event in the realm of economics, certainly in the long term and even in the medium run of four to five years.

Exports accounted for 10.6 per cent and imports 12.3 per cent of GDP in 1996-97. Indias exports account for just 0.67 per cent of world exports, down from 1.05 per cent in 1960-61 but slightly up from 0.55 per cent in 1991-92. Exports accounted for 57.2 per cent of total imports in 1960-61 but improved to 93.9 per cent in 1970-71 and to 95.4 per cent in 1993-94. The ratio fell to 91.9 per cent in 1994-95 and then to 87.5 per cent in 1995-96. This is largely because of liberal imports.

The second devaluation on June 5, 1966 evoked intense political opposition. Exports of traditional items slumped and the dollar value of exports fell for three years in succession thanks to the removal of export subsidies. The balance of payment improved in 1966-67 but largely because of the decline in imports. Food imports fell because of agriculture recovery in 1968 and capital goods import fell with a fall in investment.

The 1991 devaluation of about 20 per cent in two steps and the IMFs bail-out package was preceded by high inflation and political uncertainty. The trade deficit was Rs 10,645 crore. Again, the impact on exports was slow and uncertain. Exports in dollar terms declined by 1.5 per cent in 1991-92 but rose by 3.8 per cent in 1992-93, and by 20 per cent in 1995-96. The slide set in after that. This period was marked by a rise in international trade and bullish prices for agro-based commodities. The current scenario has none of these.

The basic issue is one of striking a balance between short-term export benefits (trade lobby) and long-term investment (growth). But confidence holds the key. The international investing communitys confidence in the Indian economy may get a jolt if devaluation takes place.

In the past, devaluations were seen to be politically unpalatable and suspect in terms of their desirable impact on the economy. And with political uncertainty hanging over the economy like a dark cloud, rupee devaluation may lead to erosion of confidence in the Indian economy besides having an adverse impact on investment, inflation, deficit and trade balance. As a wag put it: Devaluation is like inventing a monster and then trying to kill it. Most often you just cannot kill it.

With political uncertainty hanging over the economy like a dark cloud, rupee devaluation may lead to erosion of confidence in the Indian economy besides having an adverse impact on investment, inflation, deficit and trade balance

Though a correction is necessary, to press for an outright devaluation to save exports is a bit flighty,