The appreciating rupee has played havoc with exports, pushing down export growth to 8% in February and 9% in March.
But this is not the first time the Indian currency has been appreciating.
After reaching a low of Rs49.06 to the dollar in May 2002, the rupee appreciated steadily, reaching a high of Rs43.55 to the dollar by April 2004. It fluctuated between Rs44-46 per dollar till September 2005, after which it went down again to Rs46.90 in July 2006, before starting the climb back to the current nine-year high levels.
The rupee has also gone up against the currencies of most countries that are our competitors in exports, although much depends on the initial date for the analysis. For example, the Indian rupee has gained 5.2% against the Chinese yuan in the last one year, but it has actually depreciated by 1.3% since 7 May 2005.
In fact, it wasn’t so long ago that the rupee was appreciating against both the dollar and against the currencies of our export competitors. Against the yuan, the rupee appreciated 2.6% between May 2004 and May 2005 and by 8.8% between May 2003 and May 2005. Despite the rupee appreciation over 2003-05, the export performance was never better. Consider the growth in exports over the period: 2003-04: 21.1%; 2004-05: 30.8%; 2005-06: 23.4%.
So, why have exports dropped off a cliff now?
“The pace of appreciation has been very rapid,” says Partho Mukherjee, head of treasury at UTI Bank. The rupee has depreciated by 7.5% against the dollar since end-February.
As Ajit Ranade, chief economist with the Aditya Birla Group, points out, exporters usually get their proceeds within 90 days and such a sharp appreciation erodes almost all their margins. Some argue that 2007 is not 2005, because the US economy is much weaker now.
That may be true, but the world economy grew by 4.9% in 2005 and it is forecast to grow at the same rate this year. So, there’s no reason why India’s export performance should falter on that count.
It’s probable, therefore, that the real problem has been that of too rapid an appreciation. The Reserve Bank of India (RBI) has, in recent months, not adhered to its stated policy of ensuring that movements in the currency are gradual.
Why has RBI not intervened? One theory is that the central bank has shifted focus to controlling inflation, which is why it has allowed the rupee to go up. Another is that the extent of dollar inflows is so strong that RBI is finding it difficult to cope with it.
What should be done? Forex dealers point to RBI replenishing its armoury of market stabilization bonds as evidence that they’ll soon intervene. Ranade is emphatic that they should. “Foreign currency should not be allowed to become a domestic problem,” he says. A lot of exports are generated by small businesses, which do not have the opportunity to hedge their exposures, Ranade adds.
Indranil Pan, chief economist at Kotak Mahindra Bank, says that appreciation often becomes self-fulfilling, as foreign investors pour in money to benefit from the currency appreciation.
What of the future? Citigroup believes that the experience of other Asian countries, such as Japan, Korea and Taiwan, has shown that currencies start appreciating once their economies take off. India is expected to follow the same route. In the near term, however, if the currency continues to appreciate and exports continue to languish, the current-account balance may deteriorate significantly.