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What's with the Rupee?

Oct 4, 2007

The Indian Rupee hit a nine-year high of Rs 39.4 against the US dollar recently. The Rupee that once traded at Rs 47 or 48 per Dollar, now hovers near Rs 40 to the dollar. It has been the fastest appreciation of the Indian currency in three decades. The rupee has appreciated 13% YoY over the last year. The sudden rise is the result of India's growing ability to attract global capital. However, its impact on Indian exports, and through this its potential to hurt key sectors such as technology services, pharmaceuticals and textiles is a cause of worry. In the month of September 2007 alone, Rupee strengthened by 2.6%. This has naturally raised doubts on achieving the US$ 160 bn export target set for FY08 (increase of 27% YoY). The major export sectors that come directly under appreciation threat are IT and services, textiles, leather, sugar and pharmaceuticals. In rupee terms, exports rose by mere 18.9% in July 2007 as compared to 41% a year ago. In the first four months of FY08, exports witnessed a growth of only 18% and need to scale up by 31% in the remaining 8 months for the target to be achieved.

Dutch Disease
The RBI's deputy governor, Rakesh Mohan referred to the effects of the rupee's appreciation as a case of "Dutch disease". The term refers to episodes where large inflows of foreign exchange, usually as a result of the discovery of natural resources or massive foreign investment, leads to appreciation of the currency, undermining a country's traditional export industries.

US accounts for a large chunk of India's exports. A slowdown in the US could cause worries for the Indian exporters as the US economy reduces its imports. Already in 1QFY08, most of the IT companies have been unable to meet their forecasted quarterly earnings. Another sector to be badly hit, is the Indian textiles sector. It faces tough competition from China, Bangladesh and Pakistan. The currencies of these countries have not been appreciating as much as the Indian Rupee. The US is the biggest market for the textile sector. Slowdown in the US economy coupled with the appreciating rupee would reduce the competitiveness of the Indian textile sector. Similarly, the Indian pharma companies may lose their competitiveness to China and Eastern European countries. Rupee appreciation will impact the profit margins and the pricing. Further, nearly 65% of India's exports come from the SME segment (Small and medium enterprises) that enjoy thin profit margins, which will shrink further thanks to Rupee appreciation.

In India as most of the traditional exporters like textiles, chemicals, gems and jewellery have been labour intensive. Thus exports are linked to employment to a large extent. IT, textile and SME are all employee intensive industries. According to estimates by the Federation of Indian Export Organisations (FIEO), around 3.5 m people have lost jobs in the last couple of months. To give the exporters some relief, the government announced a US$ 320 m relief package for them to counter the enormous losses they were facing due to the rupee appreciation. Further, government is also refunding the service tax that exporters pay for port, road transport and rail services to ease some pressure.

Advantage India
On the positive side, rupee's appreciation has benefited the economy by making imports cheaper. Our three principal imports are crude, gems and jewellery, and capital goods.

India imports 75% of its crude oil requirement. The appreciating rupee has helped to lower the effect of higher crude price recently (Brent crude prices hit a record high of US$ 84 in recent times). As India pays its oil import bills in Dollars, the costs were lowered significantly. Further, India is importing capital goods for its infrastructure development. Cheaper dollar would help reduce the costs.

The appreciation also helped Indian companies acquire assets overseas as the same became that much more affordable. It is also beneficial for Indian consumers specially students and outbound tourists.

Trade deficit
The appreciating rupee is expected to hamper export growth while encouraging imports and thereby hurt the country's trade and current account deficits are likely to remain under pressure. The trade deficit has already increased by 63% to US$ 32.5 bn as compared to US$ 19.9 bn during the same period a year ago. The widening trade deficit would also pressurise the current account deficit. The exports of software services that were funding most of the trade deficit for the last 2 years have got affected. Further, as per the Reserve Bank of India (RBI), the shortfall in the current account was US$ 4.69 bn in the three months ended June 30 2007, as compared with a surplus of US$ 2.56 bn in the previous quarter.

To conclude...
On the flip side, the Rupee appreciation led the trade deficit to widen. The RBI intervened in the currency markets to arrest the rupee's gain (US$ 3.7 bn increase was witnessed in the foreign exchange reserves during the week ended Sept 21, 2007). However, with increasing capacities for development, stronger rupee is beneficial, as capital goods get cheaper to that extent. Further, the consumers too are benefiting with increasing rupee. However, one should not only see the Dollar value, as in globalised economy, other currencies too play an important role. The Dollar has weekend against most currencies, and not just the Rupee. Following the 0.5% rate cut by the US Fed, the US dollar declined in September against the Euro (-4.7%) and the Yen (-0.9%). Even India has lost ground against the European majors. Trade with the EU represents almost 20% of India's exports and imports. Thus, though the US would continue to play an important part, other economies to have to be considered.

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