27-10-2012, 05:00 PM
Currency Conundrum: Is the Strong Rupee Good or Bad for India
Currency Conundrum.pdf (Size: 186.51 KB / Downloads: 29)
History has been unkind to Canute. The 10th century king of
England was so tired of his fawning courtiers that he took them
to the shore and commanded the waves to roll back. It was to be
a demonstration of the limitation of his powers. But Canute in
popular perception is the man who tried to turn the tide and
failed.
Today, India's finance minister P. Chidambaram and Y.V.
Reddy, the governor of the Reserve Bank of India (RBI), India's
central bank, face Canute's predicament. In the public mind, they seem to be trying to reverse an
inexorable inflow of dollars and its consequence -- an appreciating currency. Once traded at 47 or 48, the
rupee now hovers at 40 to the dollar. Observers call it the fastest appreciation of the Indian currency in
three decades.
Is the rising rupee good or bad for India? What impact will it have on the global competitiveness of
Indian firms? Should the RBI or the Finance ministry intervene? Responding to these questions and
more, experts at Wharton and elsewhere say that the rupee's rise is the result of India's growing ability to
attract global capital. While this creates problems for some companies that earn most of their revenues in
dollars -- including IT giants such as Wipro, Infosys and TCS -- it also creates opportunities for Indian
firms by making it less expensive for them to acquire overseas assets. In addition, a strong rupee is good
for the Indian consumer. It would be unwise for the government to intervene to force down the rupee's
value, they note.
What's Driving the Rise?
Dollars are pouring into India. Net investments by foreign institutional investors (FIIs) were $10.16
billion during January-June 2007. This is more than the $8 billion recorded in the whole of 2006. July
has beaten all records with an inflow of $5.81 billion (so far). The FIIs are chasing Indian stocks and
taking the markets to what many feel are levels of irrational exuberance. The bellwether Bombay Stock
Exchange (BSE) Sensitive Index (Sensex) was 15,732 on July 23 against 12,455 on April 2.
(Incidentally, that day's low -- the Sensex plunged 617 points during the day -- was caused by the RBI's
attempts to control the rupee.)
The foreign direct investment (FDI) numbers are equally impressive. In 2006-07, FDI inflows touched
$19.53 billion, a 153% increase over the previous year. (This figure includes private equity and also $3.5
billion in reinvested earnings.) The government is looking at a target of $30 billion in 2007-08. Foreign
exchange reserves stood at $214.84 billion on July 6. This is a far cry from $5.8 billion in the dire days of
March 1991, when India had to sell its gold to stave off a default crisis.
External commercial borrowings of Corporate India were $12.1 billion in April-December 2006, an
increase of 33%. Remittances from Indian workers abroad -- principally in the Gulf -- rose 15% to $19.6
billion in the same period. And non-resident Indian (NRI) deposits, attracted by better interest rates, were
also up 35% in 2006-07 to touch $3.8 billion. These foreign exchange inflows have pushed the exchange
rate to around Rs 40 to the dollar. The rupee has risen nearly 10% against the dollar this year.
Painful Squeeze
Wharton finance professor Jeremy Siegel notes (in his podcast) that a rising currency can cause distress.
"This is painful. It's been the strongest appreciation of the rupee in over 30 years as I look back at some
of the data," he says. CEOs of IT companies would agree with that assessment. Speaking at a press
conference at Wipro's Bangalore headquarters on July 19, chairman Azim Premji complained about the
"strong headwinds faced by us in the form of the appreciating rupee." Wipro reckons that its operating
margins were lower by 2.4% in the first quarter because of the currency appreciation. Most IT companies
-- the poster-boys of India's economic liberalization -- are in the same boat; they have been unable to
meet their forecasted quarterly earnings. Their shares have been beaten down on the bourses, even as the
markets are hitting new peaks.
Infosys chief mentor N.R. Narayana Murthy notes, "It (the rupee rise) is a macro-economic issue. I am
not worried about factors which are out of my control." Others aren't taking it as easy. "A rising rupee
can have a large impact on Indian exports and it could erode our competitiveness in the global market,"
IT firm Satyam founder and chairman B. Ramalinga Raju told The Economic Times recently. "Countries
such as China are continuously suppressing the value of their currencies. So they may have an edge over
us.. The government should intervene to bail out exporters who have been hit by the strengthening
rupee." (The Indian government has announced a $3.5 billion package to provide relief to exporters in
several sectors. But that has been deemed by many as insufficient.)
Government's Role
When companies and industry organizations complain about such issues, the veiled -- and sometimes
not-so-veiled -- argument is that the government should step in to provide support. Should it?
"My feeling is no, they should not intervene," says Siegel in his podcast. "My historical studies showed
that a lot of the 1997 crisis was because currencies did not appreciate. That was during the era of fixed
exchange rates in Thailand, Taiwan, Indonesia and the Philippines. And by not letting them appreciate,
they actually attracted more capital. By letting it appreciate, people are a little bit more cautious because
it looks a little more expensive now. And all of the capital that came in -- they couldn't deploy it
favorably, and the result was over-consumption, deficits and then finally devaluation."
"I think it is best not to interfere," agrees Wharton's Raju. "Some correction should take place by the end
of next year as U.S. expenditures outside decrease." Raju adds that in the short run, "A case can be made
to support the very small exporters. But the right way is to allow the rupees to flow out. Let Indians
invest in the U.S. -- not just companies, but also individuals. Some recent steps are in the right direction.
More can be done.