Exchange Rate Movements and Its Impact on Exports of Engineering Goods

Background to the Study

Textiles and engineering goods constitute very important categories of Indias export basket, together accounting for over 35% of Indias total exports (in dollar terms) in 2007-08 The aggregate share of these two sectors has come down from 39.5% in 2003-04 to 35.1% in 2007-08.

Share of textiles export has come down steeply from 20.0% in 2003-04 to 12.0% in 2007-08 Share of engineering goods has increased from 19.4% to 23.1% over the same period.

Background to the Study

Export performance of engineering goods and that of textiles and clothing sector has been analysed in details first on 2 digit level and then on 6 digit level for select items. Analysis of data in selected categories indicates

Consistently good performance of engineering goods export and the fluctuating and mostly poor performance of the textile exports hint at exchange rate neutrality and influence of other factors on exports.
Therefore, the study also examines the non-price factors affecting the export of these commodities.
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Objective of the Study

The broad objective of the study is to analyse the export performance of the Textiles and the Engineering goods sector in India with a view to suggest policy for improving performance. This broad objective can be divided into three sub-objectives:
1) 2)

To determine the determinants of exports in these sectors To determine the major problems faced by the exporters in the sectors Based on (1) and (2) Suggest policy measures for improving export performance To review the policy changes affecting the Textile & Engineering exports with a focus on exchange rate policies. To examine the criticality of exchange rate in affecting the competitiveness of textile & engineering goods exports. (Price vs. Non-price factors)
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3)

Objective 1 has been further divided into the following parts:

Sample Survey

Samples are designed based on stratified sampling.

The stratification samples are value of exports and NIC codes.

from each NIC codes firms with high and low values of export are included. different NIC codes represent different categories of textile and clothing and engineering firms.

FGDs, Locational & Sectoral Distribution

Location Date Jointly With Sector Covered Textile & Engineering Questionnaire Received 12 (T) 6 (E)

Bangalore

30th May

VITC & FIEO (with support from FKCCI, AEPC, EEPC) EEPC

Chennai

1st June

Engineering

40

Karur

2nd June

Karur Textile Manufacturer & Exporters Association. Tirupur Exporters Association

Textile

19

Tirupur

3rd June

Textile

10

FGDs, Locational & Sectoral Distribution

Location Mumbai Pune Date 9th June 10th June Jointly With TEXPROCILE MCCAI & MIT School of Telecom & Management Studies Gujarat Chamber of Commerce and Industries Gandhidham Chamber of Commerce Sector Covered Textile Engineering Questionnaire Received 19 40

Ahmedabad

11th June

Textile & Engineering Textile & Engineering

2(T) 3 (E) 5 (T) 5 (E)

Kandla

12th June

FGDs, Locational & Sectoral Distribution

Location Vadodara Date 12th June Jointly With Sanjeeveni International Business Consulatants, Vadodara. EEPC Sector Covered Textile & Engineering Questionnaire Received 5

Mumbai

19th June

Engineering

12

Ludhiana

June July 23rd July

Regional Jt. DGFT Regional Jt. DGFT

Textile & Engineering Textile & Engineering

18(T) 30(E) 5 (T) 10 (E)

Kolkata

Clusters & SEZs Covered

The clusters which are covered are

Tirupur Knitwear Karur Home made linens Chennai Automobile

Kandla Falta

SEZs

Research Design

Broadly two categorization:

Exchange rate fluctuations and currency hedging 2) Identifying non-price factors affecting export performance
1)

Non price factors identified include:

Technological changes Foreign ownership and cross-border ventures Effective utilization of human capital Business Environment and government policy rules and regulations Credit Availability Barriers on Trade, including NTBs Exim documentation procedures and logistics

Survey Results Regarding Price-factors

Variables Incorporated Results US Dollar 70%

Euro
Currency in which exports are done Pound Yen Others Exchange rate affects export performance Yes No

20%
5% ---5% 95% 5%

During April 2007 to March 2008 rupee appreciation has affected export performance
Exchange rate appreciation is taken into account while quoting price Price level negotiated every time export deal is stuck

Yes
No Yes No Yes No

75%
25% 60% 40% 30% 70%

0-5%
5-10% If rupee appreciates by 5-10% what extent price changes? 10-20% 20-30% >30%

70%
20% ----------

Survey Results Regarding Price-factors

Whether hedging is undertaken? Yes No Forward Hedging What type of hedging is undertaken? Future Hedging Option Hedging Others Yes Hedging strategy guided by various schemes offered by banks No Dont know Hedging strategy guided by similar practice in the sector as a whole although unaware of the adverse consequences. Yes No 50% 50% 100% ---------20% 15% 65% 10% 10%

Dont know
Yes No Dont know Yes No

70%
30% 10% 60% 15% 80%

Has RBI taken enough initiatives to facilitate exporters in adopting correct hedging strategy?

Benefited from rupee depreciation during April 2008 to March 2009

Survey Results Regarding Price-factors

1 2 Importance of exchange rate in a scale 1 to 7 (1 very low, 7 very high) -------

3
4 5 6 7 1 2 3 4 5 6 7

10%
20% 40% 25% 5% ---10% 40% 30% 15% 5% ---35% 65%

Importance of non price factor in a scale 1 to 7 (1 very low, 7 very high)

Engineering firms reporting exchange rate as >=5 Textile firms reporting exchange rate as >=5

Exchange Rate & Export

The notion in the field about the exchange rate is much stronger. Among the exporters surveyed, more than 70% have rated exchange rate as one of the most important factor affecting export performance.

Interestingly, in our survey result 65% of the textile firms have rated the importance of exchange rate at >=5; while the same for the engineering firms surveyed is only 35%.

Exchange Rate & Export

It appears that since the primary level survey was conducted at a time when the economy was in the throes of depression, some of the hardships faced by exporters due to the meltdown added to the woes due to rupee appreciation.

This is especially true for textile exporters who not only operate with lower profit margins and hence are more vulnerable to exogenous changes but also because their exports were more severely affected by the meltdown than that of engineering exporters. Further as the gestation period is much shorter for the textile export than that of engineering exports, textile export orders are more prone to cancellation than that of engineering sector.

Exchange Rate & Export

Month 10.1.2007 10.2.2007 10.3.2007 10.4.2007 10.5.2007 USD 44.53 44.05 44.28 42.91 40.98 EURO 57.73 57.45 58.21 57.32 55.43

Currency rates as on 10th of every month

10.6.2007
10.7.2007 10.8.2007 10.9.2007 10.10.2007 10.11.2007 10.12.2007 10.1.2008

40.98
40.38 40.63 40.71 40.50 39.33 39.40 39.29

54.34
54.88 55.4 55.73 55.62 57.5 57.52 57.5

24% Appreciated

Forward Covers Done Here

Exchange Rate & Export

Month 10.2.2008 10.3.2008 10.4.2008 10.5.2008 10.6.2008 10.7.2008 10.8.2008 10.9.2008 10.10.2008 10.11.2008 10.12.2008 10.1.2009 10.2.2009 10.3.2009 USD 39.55 40.56 40.00 41.67 42.85 42.98 41.94 45.11 48.68 47.29 49.13 49.09 48.69 51.55 EURO 57.73 57.92 62.95 64.19 66.78 67.91 62.82 63.81 65.97 60.81 63.56 66.99 62.43 64.74

23% Depreciated

US Crisis

Exchange Rate & Export

The Indian rupee started 2007 at Rs 44 to a dollar and steadily appreciated through the year to close at Rs 39 to a dollar in December 2007. Most Indian exporters had not anticipated that the rupee would strengthen by 11 per cent across the course of the year and their bottom lines were adversely affected. At the time it was the view of many institutions, including banks that the rupee would strengthen further against the dollar, to levels around Rs 36 to Rs 37. Not surprisingly, given prevailing sentiment and professional advice, Indian companies aggressively hedged their future dollar cash flows on the assumption that the rupee would stay stable or strengthen. The idea that it could dramatically depreciate was not considered. By mid-2008 the rupee had fallen to Rs 48 to a dollar - a drop of 25 per cent.

Exchange Rate & Export

Sudden excessive volatility makes the task of managing exchange rate risk very difficult for exporters who run a multi-currency balance-sheet. And, in a classic case of a double whammy, suddenly rupee depreciation was not the only problem facing these companies. Some organizations had hedged some percentage of their future receivables, based on projections for the business. Unfortunately, the crisis had the effect of causing orders to dry up such that even maintaining the past year's order levels became difficult, let alone achieving growth.

Exchange Rate & Export

Among interviewed exporters during the survey almost 50 per cent undertook forward hedging, but among them 70 per cent didnt know about RBIs initiatives / guidelines on derivative hedging or thought that RBI has not taken enough steps. During mid - 2007 when rupee started appreciating, many manufacturers faced difficulties by way of 10 to 15 per cent drop in the revenue. They could not find any way of compensating this from the overseas customers. During this period some foreign banks lured the manufacturer-exporters and entered into derivative contracts. Mostly the clients in manufacturing sectors are less informed on the complex clauses of the contracts. Their sole objective is to protect the revenue/limit the risks. RBI has framed guidelines to regulate derivative transaction in order to protect customers from major risks. The foreign banks often overlook these regulations and make unequal contracts and leverage to their advantage.

Non Price Factors

The feedback received from exporters indicate that non-price factors also affect their export performance adequately. Among the non-price factors, the importance of the following have been highlighted by the exporters

Availability of Credit Technological Modernization Cross-Border ventures and foreign interest in your firm Training of the workforce Labour Market Regulations and trade unions Export Documentation and Logistics Tariff and Non-Tariff Barriers

At least 70 per cent of the exporters have reported that availability of credit is the major non price factor affecting their export performance and have rated as more than 5 in the scale of 1-7. 40 per cent graded logistic as 5 and same for labour market.

Non - Price Factors Affecting Cotton-Textile Sector

The Indian textile industry has been one of the foremost contributors to the country's employment, exports, and GDP. Globally, the Indian industry is recognized for its competitive advantages, especially in the cotton segment. Currently the textile industry is one of the worst hit sectors in India, as almost 50 per cent of the industry is dependent on exports. India has doubled the production of cotton in five years and has sufficient cotton to feed the growth of the industry. India is the second largest producer today and has also become the second largest exporter of cotton. This means that India has a clear advantage on the cost of cotton. However, in reality, it is not necessarily true the relative advantage of India vis--vis competing countries like Bangladesh, Pakistan, Vietnam, Indonesia and Thailand has come down, with the gap between Indian cotton price and that of the other countries reducing over the last five years due to the acceptance of Indian cotton by other nations and large scale exports from India.

Non - Price Factors Affecting Cotton-Textile Sector

The most alarming point is that the landed cost of Indian popular cotton Shankar 6 is cheaper or equal for mills near the ports in the far eastern countries and Pakistan and Bangladesh by road as against the same for the south Indian mills (Tamil Nadu has the maximum number of spinning mills in India).

Road transport is much more expensive than sea transportation, e.g. it costs $50 (Rs 2,500) to transport 150 bales from Mumbai to China and it costs Rs. 75,000 to transport it from the place of production in north and western India to Tamil Nadu.

Further, in a falling global market where prices were falling across the board, the Government hiked the minimum support price (MSP) of raw cotton by 40 per cent, making the raw material expensive for the local industry, when on the other hand the price of end products were falling. The industry started experiencing a squeeze both ways. We have a restriction on labor flexibility, making it very difficult for the garment industry, which has seasonal loads of work thereby allowing very limited space for companies to adjust to the changing times and seasonal demands.

Non - Price Factors Affecting Cotton-Textile Sector

High power tariff and frequent power cut is one of the major problems faced by the exporters. Tirupur exporters reportedly faced an increase in cost of production by three times due to the use of generating system Fuel / energy cost for textiles industry:

India 8.87 cents / Kwh China 6.04 cents / kwh Indonesia 3.65 cents / Kwh Bangladesh 3.45 cents / Kwh

In India, the high incidence of taxes on industrial fuels and shortage of power from the grid have pushed up the cost of production costs.

Problems in Engineering Sector Due to Global Meltdown

The hostility in the global trading environment is now affecting engineering sector too which is now facing considerable demand problem in global markets and are under acute distress. Certain segments of Indian engineering industry such as hand tools, bicycle and parts, castings, auto components, and similar other low value added engineering units are in no way different from the textile and leather sector, in terms of their shrinkage in demand leading to loss of output and employment. However, the Government has consciously refrained from supporting the engineering sector as there is a belief that engineering exports will pull through.

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Problems in Engineering Sector Due to Global Meltdown

Banks are not issuing letter of credit due to credit non availability in various countries. LCs are being restricted to counters of certain banks who are overcharging Indian exporters as banks want to increase their own revenues by way of bank charges which is totally unregulated in India as any bank can charge any thing and there is no transparency or restrictions in place. EU and North America, which so far attracted 40% of Indias engineering exports but are facing sever crisis at present. As orders from western markets like the US and Europe shrank drastically, Indian engineering companies were compelled to reduce their output levels and resort to lay-offs for cutting costs. Consequently, they were compelled to revamp their production lines and reduce their work hours. Reduced output and declining sales growth also compelled units to lay off their workers. Large no. of SMEs are running under capacity resulting in half a million job losses in the last few months.

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Policy Recommendations

There is a notion that in the present system, RBI is mandated with numerous objectives managing public debt, exchange rate, and finding a balance between growth and inflation. These tasks often come in conflict with each other.

For example, according to RBI circulation (Dated 13th July, 2007), the Government has decided to provide interest subvention of 2 percentage points p.a. to all scheduled commercial banks in respect of rupee export credit to the specified categories of exporters in textile, readymade garments and engineering sectors among other sectors. But according to the feed back received from exporters, such circulars do not often reach them in time and where exporters do get such circulars there exist some confusions regarding the implementation. RBI may ensure that most of the circulars that benefit exporters particularly with regards to credit are adhered to by the implementing agencies, viz. the commercial banks. For this, RBI can make the exporters aware of the existence of the banking ombudsmen and the later should also be made aware of the problems faced by the exporters in this regard.

Policy Recommendations

Information dissemination is asymmetric, in the sense that the foreign clients are aware of many of the RBIs circulars for the benefit of exporters much before they reach Indian exporters. Consequently, exporters are unable to bargain with their customers in terms of price, when exchange rates fluctuate unfavorably.

Our exporters may take advantage of such benefits if RBI is likely to ensure that information is disseminated to exporters through the export promotion councils. The later should be made responsible for passing on the information to the exporters in their respective domain.

As per the Basel II accord, banks are insisting on credit rating, i.e. creditworthiness of exporters. Imposing such norms create problems, particularly for the small exporters. RBI can instruct the banks to relax the credit rating requirement for a loan requirement of a particular amount.
Whenever a fluctuation in US dollar vis--vis rupee is anticipated a priori, viz. on election result date, on the date of budget announcement etc., the RBI may intervene more in the foreign exchange rate markets to prevent any speculative opportunities in the foreign exchange market.

Policy Recommendations
Among other issues that have emerged during interaction with individual exporters:

Exporters have suggested for the creation of special purpose vehicle (SPVs), a mechanism through which exporters can share the exchange rate risk with the RBI, with a premium which can be collected from exporters at the time of beneficial exchange rate for them, i.e. when dollar appreciates.

We, however, strongly believe that such a suggestion is not workable. However, RBI can encourage initiation of cross-currency option trading in a limited way, in line with currency futures trading. This shall facilitate exporters who hedge against foreign exchange risk exposure only through forward hedging (as our primary survey results have suggested, 100 per cent exporters in the sample who hedged, used only forward hedging).