A secular decline in the US dollar will resuscitate America’s manufacturing industry, and it’s time Indian exporters got used to a stronger rupee in the long term, notwithstanding the local currency’s slump this year.
The US economy has been the bearer of bad news for a while, what with the spiralling household debt load, mounting housing inventory and the ongoing credit crisis, but a ray of hope is emerging from an unexpected area—the manufacturing sector.
The period between 1995 and 2002 saw an unprecedented appreciation in the greenback. While economists debated the “dollar bubble”, it led to the rapid demise of American competitiveness in manufacturing. However, over the last five years, the dollar went into a decline that may very well mark a reversal of this trend. After peaking in 2002, the decline in the dollar has only managed to take some of the froth off the greenback—there still remains a fair way to go.
While the 30% appreciation in the real, trade-weighted dollar, or over-appreciation as some would likely term it, was reflective of America’s rise as the world’s most dominant economy, it seemingly was the last nail in the coffin for its manufacturing industry. Manufacturing and exports, rendered hopelessly uncompetitive by a strong dollar, caused work to shift overseas to low-cost destinations such as Taiwan, Korea and China.
Now, in a dramatic reversal of fortunes, this sector is set to stage a comeback as the dollar slides against some of the world’s major currencies. A decline in the value of the dollar will lead to a reduction in reliance on imports, an increase in import substitution and a resurgence of the manufacturing sector.
The comeback in manufacturing is also attributable to increasing costs overseas. With sky-high shipping costs and wage inflation, the benefits of outsourcing are fast eroding. Meanwhile, America is finding cost advantages in its own backyard. With China now exporting inflation to the US, pressuring cost benefits from outsourcing, well contained unit labour costs in the US have reduced the competitiveness of its major trading partners.
Manufacturing productivity is a small part of the story, the real story is all about the dollar—since 2002, manufacturing unit labour costs in the US have declined almost?25% against major trading partners, and almost 95% of this decline is attributable to the currency. The lag effect between the dollar weakening and domestic US cost competitiveness could extend over years, but the trend has set in, as is evidenced by the surge in exports and import substitution by some businesses. Capital flows into the US manufacturing sector are also staging a comeback, lending strength to the story.
If the dollar continues its secular decline and manufacturing in the US does stage a successful comeback, what impact would such a change have? Clearly, the impact on China and other export-driven countries is far more obvious than it is on current-account deficit countries such as India.
Here is where the Indian growth story is better poised to weather the storm, although the country hasn’t truly exploited its export potential as yet. The US comprises less than 15% of India’s exports, so the following is more a comment on the effect of an indisputably stronger rupee over the next decade (not withstanding the current capital crunch scenario where the rupee flounders over the short term). Breaking down current Indian exports, manufactured goods comprise 64%, dominant sectors within that being engineering goods (23%), gems (13%), and garments and textiles (12%).
Textiles is a prime example of the fact that nothing based just on the “cheap” mantra works forever, and in such cases currencies are wonderful tools for the distribution of global wealth—IT services beware! The gems sector has strictly been a cost-plus type of low value-added space. Admittedly less affected by a stronger currency as most raw material costs are dollar-denominated but this, again, is a sector waiting to move to the next low-cost region as the general cost levels in India move up with the country’s prosperity.
The engineering goods sector is where we think the country holds a lot of promise, where the share in total exports seems to have unfortunately stagnated over the last few years after rapid growth for several decades. This is where we have observed a very serious inclination to move up the value chain, such that currency appreciation isn’t the only variable that defines competitiveness.
A case in point are auto parts within the engineering goods space: Now, companies such as Bharat Forge Ltd and Amtek Auto Ltd aren’t merely getting work outsourced to them, but are increasingly being considered true partners by their global OEM (original equipment manufacturers) customers.
Make no mistake, exports will always be affected by global cyclicality and forex moves over the short term, but long-term competitiveness can only be established if one can weather both, and that’s where we see the potential of India’s engineering products.
Whether this space is adequately exploited or not could make the difference between the current account deficit further ballooning as uncompetitive exports fall off, or the deficit actually shrinking.
Rajeshree Varangaonkar and Bharat Indurkar have day jobs with US-based hedge funds. They will write every other Thursday. Send your comments to firstname.lastname@example.org