Reflections on the Rising Rupee

The Indian Rupee (INR) has appreciated vis-a-vis the US Dollar considerably in the recent period. It has gained almost 13 per cent since July-Aug last year. Even as recently as a month ago, it was moving in the range of Rs 44-45 per Dollar; now it is between Rs 40-41. Who all are happy and who all are worried?

 

The government is obviously happy, for two reasons. One, politically speaking, it gets some bragging brownie points. Though Finance Minister P Chidambaram said, "The government has no view on exchange rates", the ruling class can afford to say that the stronger INR is all due to their 'efforts', especially when elections are on in the all-too-crucial UP. May be, just may be, the guilt of mismanaging the economy in the late 80s and early 90s and having had to devalue INR is still there in the minds of Congress people (Oh, yeah?! You sure?!!!) and the gains made by INR may help assuage such feelings! Second, the government has been able to tame inflation at least a bit: WPI based headline inflation has come down to 6.09% from 6.72%, but is still far too above RBI's comfort levels.

 

Besides all these, a Credit Suisse report released recently has said that the rally in INR has made India a Trillion Dollar GDP economy. India's GDP has been put at Rs 41,00,000 Crore, which at Rs 40.72/$ translates to a little over $1 trillion. With this, India becomes the 12th member of the Trillion Dollar Club, the others being the US, Japan, Germany, China, the UK, France, Italy, Spain, Canada, Brazil and Russia. According to the same report, the Indian stock market capitalization too is closing fast on the trillion dollar level. Music to stock brokers' ears!

 

Another set of people who are rejoicing are the importers, in general and oil companies, in particular. Rising Rupee will help improve their margins. It remains to be seen whether they will pass on the benefits to the consumers.

 

In this context, the role of the RBI is surely worthy of a mention. Though our exchange rate mechanism is said to be market-determined, it was an open secret that RBI discreetly controlled it. All along, RBI used to buy up all dollars coming into the economy and this used to get added to our forex reserves, which recently crossed the $2 billion mark; the Rupee that were issued instead were mopped up by what was called 'sterilization' using government bonds under the Market Stabilization Scheme (MSS). However, many questioned this intervention of RBI and the effectiveness of its sterilization operations. The recent bout of high inflation was at least partly due to this, it was alleged. What has happened now? Though the RBI maintains that there has not been any change in its external sector management policy, the RBI has been conspicuous by its absence from the market in recent times. Is it because it has not enough MSS bonds or is there an ace up its sleeve? No one knows. Also, the RBI has concerns about the quality of the money coming into the country. It is now acknowledged that at least part of the dollar inflows is speculative in nature, called by different names like 'carry trade', 'private equity', 'hedge funds', etc. In a recent interview, the RBI Governor Dr YV Reddy hinted at RBI's helplessness in controlling such inflows which arise from policy flaws.

 

Rising Rupee has implications for India's Balance of Trade (BoT) position too. Unlike most other Emerging Market Economies (EMEs), India has a significant deficit in its Current Account. Coupled with a surplus in the Capital Account, a substantial portion of which is a mere mouse click away from flying out, it presents a tricky situation. The need for export competitiveness cannot be overemphasized. Appreciating INR will make it difficult to achieve the export target of $160 billion laid down in the recently released Annual Supplement to Foreign Trade Policy. Naturally, the exporters are a worried lot. If INR gains, it will eat into their wafer-thin margins and many will be forced to down their shutters. Then again, the sunrise IT sector feels threatened as most of their clients are US-based. Bigger firms which have the professional competence and access to hedging tools are better off, but it is the smaller firms that will be hit hard the most. In this context, the RBI's move to allow companies categorized as SMEs to book forward contracts without any past records of forex trade or any underlying exposure, is commendable. The RBI has also taken measures to ease Rupee outflows. All these have to be supplemented with activities to educate the small and medium exporting units on using hedging tools effectively.

 

Finally, amidst all this is a report (by JP Morgan? I'm not sure) that the INR is overvalued by about 11 per cent at current levels. This complicates the situation. Is the appreciation temporary? Will the Rupee plunge below the 50/$ mark? Only time will tell. Another aspect that calls for immediate attention is the need for cost reduction in all sectors of the economy. Though cost control and cost reduction are essential ingredients for the success of any organization, its significance becomes manifold for export-oriented enterprises, especially in the context of a rising Rupee. It is both an opportunity and a challenge for Cost and Management Accounting professionals. There is this dire need to instill cost consciousness in our economy and the rising rupee is the perfect excuse to initiate a cost reduction drive in all industries and sectors. Cost reductions and innovations are necessary to stave off the challenge posed by other low cost destinations like Philippines.