They say on Wall Street that no one rings a bell telling you that it’s time to get out. Our experience in the context of the dollar depreciation phenomenon is that the bells have been ringing for the last five years, and very loudly at that for the last couple of years and yet, few people cared. When the precursor to the trend of an appreciating rupee manifested in the last few months, one would have expected some serious analysis and thoughts within the industry here.
But all Kiran Karnik, president of Nasscom, had to offer at the recent ITES-BPO strategy summit was superfluous explanations with very few solutions. His analysis is quoted verbatim below:
Cause: “… the other countries are holding their currency steady against the US dollar.”
Effect: “The rupeeappreciation in the long term will not only impact the bottom lines, but also erode the country’scompetitiveness.”
Remedy: “Nasscom has... engaged in a dialogue with the government for some kind of intervention. Extension of tax incentives would help the industry to partially offset losses... caused by the appreciating rupee.”
Are these claims supported by data and is there any economic logic underpinning these assertions?
Contrary to Nasscom’s claims that all currencies have been steady, between January 2002 and July 2007, all currencies have appreciated against the dollar! And most currencies have appreciated far more than the rupee. The graph shows a few. Others include the Canadian dollar, which appreciated by 52.2%, the pound (39.9%), the New Zealand dollar (89.9%), Norwegian kroner (56.1%), the rouble (19.6%), the South African rand (72.6%), the Swedish krona (57.1%) and the Swiss franc (37.9%). The one situation justifying their claim is that they were referring to only the last three months. But why take such a short-term picture when referring to a structural issue? Clearly, the claim of Nasscom that only the rupee has appreciated is factually incorrect. Unless of course, they were referring to the Mexican peso or Zimbabwe dollar when they meant “other currencies”.
An appreciating currency is a consequence of a nation’s competitiveness in international trade. If a depreciating currency were to aid in a nation being competitive, then Zimbabwe would be amongst the most competitive of nations today.
A study of history would show that nations have “never” become competitive on the back of a depreciating currency. In fact, countries for long periods of time have emerged more successful and competitive with the help of an appreciating currency, i.e., the US right from the beginning of the century till the late 1960s, Germany and Japan post the World War II situation. Not only did these countries have an appreciating currency, but they also had amongst the highest wages and still emerged competitive in international trade.
So, the statement that an appreciating currency hurts a nation’s competitiveness displays a complete ignorance of history and economics.
In asking for the government’s help, Nasscom has displayed as much faith in market forces as Hugo Chavez. There are many number of ways that exporters can deal with an appreciating currency and, instead of relying on market solutions, Nasscom has unfortunately sought government protection.
But what is the impact of deliberately undervaluing the currency? By doing so, we hurt the inherent purchasing power of the currency and so it would be a case of ordinary citizens subsidizing the exporters. I really wonder if Nasscom even thought through the ramifications of their request to undervalue the currency.
I would actually agree partly on this, though for reasons very different from what Nasscom has suggested. I think it’s always good to have lower tax rates that encourage competition, investments and entrepreneurship. Indeed, one of the required conditions for a nation’s becoming competitive is low tax rates. So the government should indeed lower tax rates. But it should be for all industries and companies, as otherwise what we would end up doing is distorting the normal market process of capital allocation.
We think tax incentives are not the best way to promote a new industry, let alone justifying the same for a reasonably mature industry such as ITES-BPO.
The claims of Nasscom are factually incorrect; the arguments have flawed economic logic; and the proposed solutions are retrograde in a market economy. Not only are the observations illogical in the cause-effect sense, but they also make little sense on a stand-alone basis, i.e., even assuming that the cause is correct, the analysis of effects is wrong; and even if the analysis of effects is correct, the proposed remedies don’t stand up to economic scrutiny.
Even if Nasscom genuinely believed that the rupee is overvalued, there is no justification in their asking for government intervention. Everybody has a right of opinion in what they think is the correct level of exchange rates. For example, even after the significant depreciation over the last five years, I think the dollar is massively overvalued and have written extensively about this (refer http://financial-musings.blogspot.com). But given my belief that the rupee is undervalued, it does not mean that I start clamouring for RBI’s intervention. Ultimately, it is the market that should determine the exchange rates, and asking for interventions either to undervalue or to overvalue (as we did in the 1980s) would have economic consequences that are not good for a society.
It’s best that the exchange rate function is left to the markets with companies learning to tackle the currency fluctuations as part of their operating issues. One would have expected Nasscom to actually show the way. After all, this was the institution that not-so-long ago welcomed competition for talent from the multinational software companies and indeed emerged victorious. Where has all that spirit of enterprise and innovativeness gone?
S hanmuganathan N. is director, Benchmark Advisory Services. Comments are welcome at email@example.com