The Rising

Inflation control is pushing the rupee up. But the macro problem is the policy logjam that hinders the absorption of increasing inflows triggered by growth.

PICTURE SPEAK

ROUGH RIDE: Rising inflows of almost $4 bn a month have fuelled the rupee’s risen

The impact is just as visible. Exports have slowed down from 26.3 per cent between April and December 2005 to 19.3 per cent between April and December 2006. The worst hit is the gem and jewellery sector, which has slid from 22.5 per cent growth between April and November 2005 to a negative 0.8 per cent. Also hurt badly are textiles and textile products, where export growth has slipped from 21.8 per cent to 8.6 per cent this year. It’s early days yet and the full picture would be known only by July as data for the first four months of the year when the rupee slid sharply, will come in. Preliminary reports suggest export growth could be down to a single digit. Not surprisingly, exporters have begun the rupee chant. S. Sakthivel, executive secretary, Tiruppur Exporters Association, wants the Reserve Bank of India (RBI) to intervene immediately or else Pakistan and China will gain market shares. Even as other exporters join the chorus, Commerce Minister Kamal Nath has voiced his concern: “The rise in the rupee is worrying for exports, the manufacturing sector and the economy at large.”

"The rupee rise is worrying for exports, manufacturing and the economy at large." KAMAL NATH, COMMERCE MINISTER "The appreciation threatens India’s exports, industry, growth and employment." SHANKAR ACHARYA, DIRECTOR, ICRIER

The cause is the consequence of managing a complex economy moving into a higher growth trajectory. To control inflation, RBI has to curb money supply, which has grown 20.8 per cent in 2006-07 compared to 17 per cent the previous year. With nominal GDP (GDP plus inflation) growth at around 14 per cent, liquidity was inflating costs and heating the economy. Ergo, RBI first targeted the cost of money by pushing up interest rates. This resulted in corporates going abroad and bringing funds via external commercial borrowings. Higher interest rates also resulted in NRI flows doubling from $1.6 billion in April-January 2006 to $3.6 billion in April-January 2007.

Clearly the massive inflows of forex were adding to the liquidity and RBI’s woes. As Anand Krishnamurthy, head of treasury, HSBC India, points out, India being the flavour of the season investments are pouring in and inflows are outstripping outflows. Between April 2006 and March 2007, India added over $42 billion to its reserves, of which $20 billion were added between January and April, with $11.8 billion flowing in just in February. Buying inflows means creating money as every dollar bought results in creating rupees. Indeed, between April 2006 and March 2007, RBI created Rs 1,93,170 crore as it added dollars to its reserves.

Should the apex bank intervene? Is a stronger rupee good for the economy? The answer depends on which side of the fundamental fence one is perched on. Textbook economics teaches us that strong currencies hurt exports and help imports as also help keep prices down. Real world economics is a bit more complex. Export competitiveness depends on many aspects, one of which is import content which in India is high. For instance, Mehul Choksi, CEO of Gitanjali Gems and Jewellery, explains that besides the loss in value of stocks (gold and diamond), a weaker dollar will hurt competitiveness by just about 2 to 3 per cent as the value addition is about 20-30 per cent. Those with lower value addition will obviously be hurt more.

In the software sector, V. Balakrishnan, CFO, Infosys Technologies, believes every one per cent dip in the dollar impacts operational incomes of it companies by about 40 to 50 basis points. Many would argue that the pain is bearable, especially as exporters get tax sops. The more extremist view is that the government cannot be the guarantor of profit for exporters. They too must adapt just as import-dependent industry adapted to a falling rupee and duties.

Surjit Bhalla, economist and MD of Oxus Research though believes “RBI is mistaken in its belief that its attempt to curb inflation with higher interest rates and a stronger rupee will yield results. Its top brass must be sent to China to learn exchange management.” After all, in the four months that the rupee gained 9 per cent the dollar weakened just 1.9 per cent against the Chinese yuan. The debate though is not just about exports. Can India afford to make imports cheaper —in the long run—just as its manufacturing sector is taking off?

There are clearly no pat answers. The debate is not exporters versus importers or the voting class hurt by inflation against the non-voting class concerned about growth. India has to plan its transition to a high growth trajectory better. Sure RBI has opened up forex use for individuals and exporters to ease the pressure of inflows. There is talk about using the burgeoning billions to fund infrastructure. Forex reserves could also be used to build up food or fuel stocks. But we still need systemic changes to enable the absorption of inflows and fund growth.

The classic definition of inflation is too much money chasing too few goods. Ergo money created by inflows needs avenues to be absorbed. If investments stuck in policy logjam are cleared, inflows—now deemed inflationary—could be used to create productive assets. The Singh Parivar needs to sense the opportunity in the problem of plenty and capitalise on the India interest. Or else the phantom of inflation could render India to be flavour of just this season.

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