India need not fear a rising rupee

Business Line, April 19, 2007 R. VAIDYANATHAN An appreciating rupee shows the strength of the economy and it will be folly to keep it rained-in. It would also be an insult to the great savers of the nation the ordinary householders, says R. VAIDYANATHAN.

ON April 16, the rupee quoted at its nine-year high against the dollar at 41.86 and it is expected to breach the 40 barrier soon. This has led to consternation in many quarters, and the Government has been urged to prevent rupee from making further gains. One important aspect of this debate does not take into account the fact that the Reserve Bank of India has injected huge amounts of liquidity into the system by trading in the currency market. Concerned about inflation and its impact on the common man, the RBI would like to keep it below 6 per cent. It has taken several steps such as raising the Cash Reserve Ratio and adjusting the repo rates to reduce liquidity in the banking system in order to put a brake on the credit growth. This tightening, the RBI feels, is imperative to fight inflation. But the RBI has also been injecting huge amounts of liquidity into the system. It has purchased substantial sums of dollars from November onwards, as can be seen from the Table The purchase of more than Rs 108,886 crore worth of US dollars impacts the banking and credit system, and inflation. On the one hand by hiking the CRR, etc., the RBI says it wants to reduce the flow of funds but to keep the rupee pegged at a lower level it is adding fuel to the inflationary fire. Zooming Forex Reserves The country's forex reserves zoomed beyond $200 billion as of March a far cry from the early 1990s, when it was scrapping the bottom, and the country had to pledge its gold to the Bank of England. Three major groups would be disappointed with an appreciating rupee.

One, exporters and the IT companies which earn a significant portion of their revenues from foreign operations. In the case of general exporters, it is to be noted that appreciation of rupee should per se not matter but the relative appreciation compared to the currencies of competing countries to similar destinations. From that point of view the appreciation of the rupee is much less than that of many other Asian currencies. As for the IT companies, it is suggested that they are going up in the value chain and hence should be able to withstand rupee appreciation better. Also it is to be noted that they are competing not on unit cost basis but on pool of talent and hence cost is only one dimension. Anyway it is no more a nascent industry and hence arguments for protection may not hold water. The second group that may not be happy about an appreciating rupee is the dollar-denominated account holders both legal and otherwise. But their concern cannot be the driver for policy formulations. On the other hand, the importing sector will benefit substantially by any appreciation of the rupee, with the merchandise import touching $14 billion. Significant benefits will come particularly in the fuel side and given the good performance of India Inc further reduce input costs. The reduction in the input cost of import would reduce significantly the inflationary pressures in the economy. Based on Purchasing Power Parity, many economists argue that the rupee should appreciate much more to reflect its true worth. For instance, it is possible to get someone to do the entire household work, cleaning, washing, etc., by paying a couple of thousand rupees a month which will translate into a measly $25, which in the US may be the hourly rate for a baby-sitter. Two-Fold Concern The concern of the planners could be two fold. The appreciating rupee could impact exports and, hence, the foreign exchange reserves. These fears are based on a deficit mindset of the 1960s when the foreign exchange reserves became a major concern leading to such slogans as `Export or Perish'. The nation has come a long way and is now self-confident and resurgent. Unfortunately most of our planners were born in the 1940s and the 1950s and lived through the scarcity and deficient years of the 1960s/1970s and hence constantly worry about possible crisis and rationing situations. Another issue often not ignored is that our reserves, kept in US Treasury bills or bonds or euro-denominated bonds, may be earning a mere 4-5 per cent interest. More important is the substantial gains the country will make if the rupee appreciates; it be an indication that it is an important economic player. At international airports and in global financial newspapers the Indian rupee rarely finds mention as a currency of importance.

India is still not on the radar screens of global fund managers and business groups, though the country has moved up from the `speculative' to `investment' grade in the ratings given by international agencies such as S&P. Hence it is important for India to look ahead than only be concerned about IT firms and exporters who may be affected by the appreciating rupee. Sectional interests are important but national interest is paramount. It is also important to remember that more than 90 per cent of India's investment is financed by domestic savings, mainly household, and not by foreign flows. The other issue is the so called" hot money" coming in via the FII (foreign institutional investors) route for the short term. The relevant issue is how to manage an appreciating rupee rather than stopping it from strengthening. In the coming years substantial FII and FDI flows along with trade receipts and other invisibles can be expected. It may not be easy for the RBI to continue with the practice of buying large amounts of dollars as that would only exacerbate inflationary pressures. Thus, the RBI can, and should, be more transparent about its huge portfolio as that would offer clues to the true monetary policy and its impact. The inflation data now made available with a lag of two months can be made available on a more frequent basis. A sense of Pride The nature of fall of dollar or rise of rupee should be observed and handled subtly so that the rupee strengthens over a period.When we travel abroad and find that a dollar can be got for Rs 20 or so, we can be satisfied with our economic prowess and also our ability to handle change smoothly. An appreciating rupee shows the strength of the economy and it will be folly to keep it reined-in. It would also be an insult to the great savers of the nation the ordinary householders. (The author is Professor of Finance and Control, Indian Institute of Management-Bangalore, and can be contacted at vaidya@iimb.ernet.in. The views are personal and do not reflect that of his organisation.) (This article was published in the Business Line print edition dated April 19, 2007)