The Infosys results have brought home the damage that an appreciating rupee can inflict on exporters. The bellwether IT services company has had to revise its earnings guidance downwards, despite an improvement in price realizations. Analysts point out that for every 1% rise in the rupee against the dollar, operating margins of IT companies are squeezed between 30 and 50 basis points. It’s no surprise that IT companies have taken no part in the current rally in the stock market.
The tough times are likely to continue for exporters, since the dollar has been plumbing new depths against most currencies. Yet, what’s important is not just the earnings of exporters (margins of software companies are still very high), but their competitive position vis-à-vis other countries’ exports. On that front, the May export figures, showing 18% growth in dollar terms, haven’t been bad at all. The possible explanation is that exports are contracted months in advance and exporters have been forced to ship these products, despite the fact that they make very little profit. That will, however, change in the future.
It’s rather obvious that the 8% appreciation in the value of the rupee in the first half of the year will badly hit profits in export industries that operate on relatively thin margins, such as textiles. It’s also true that the rupee has appreciated far more than competing currencies—it went up by 8.35% against the dollar during the first half of the year, while the yuan appreciated by 1.82% and the currencies of Bangladesh, Indonesia, Pakistan, Singapore and South Korea have risen by less than 1%. Accepting that exporters need to be protected, the government has now offered them a package of sops, aimed at mitigating some of the damage caused by the rising rupee. But exporters have been quick to point out that the package was enough to offset their losses and, unless they get more relief, many of the smaller units will be forced to shut shop, affecting exports.
What’s the remedy? The Reserve Bank of India (RBI) is doing its bit and is back in the foreign exchange markets buying dollars. As long as China follows a policy of pegging its currency to the dollar, it’s futile for its competitors to pretend that they don’t have to defend their currencies. But the problem is that when RBI buys dollars, it releases rupees into the market, which drives down interest rates. To offset this effect, RBI has to mop up the rupees, which it does by issuing bonds. But even this process, called sterilization, has a cost attached. RBI is thus caught in a cleft stick—allow the rupee to appreciate, or intervene in the market and see interest rates dip below its policy rate, negating the impact of its tightening stance. For now, with inflation under control, it is opting for the latter strategy, but it clearly faces great difficulty in coping with the rush of foreign capital inflows. One suggestion has been to lower the ceiling on external commercial borrowings. But this newspaper has argued that such limitations make little sense, because companies will find ways and means of getting around the restrictions.
Perhaps the problem lies not so much in rise of the rupee as in the pace of appreciation. Admittedly, this was excessive in April and May and, some foreign exchange dealers say was because RBI held the line too tightly earlier.
The experience of countries such as Japan, South Korea and Taiwan shows that the currency appreciates once economies take off. It’s time for companies and exporters to get used to an appreciating rupee and it’ll be up to RBI to ensure that there are no sharp rises (in fact, playing against the market sometimes could be good for RBI, just to ensure that the rupee doesn’t become a one-way bet). After all, the rupee appreciated 8.8% between May 2003 and May 2005 and export performance was never better.
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