The relentless rise of the rupee has taken most corporate decision makers completely by surprise, and they are now scrambling to evaluate the advantages and disadvantages of a strong currency.
Few had expected the Indian currency to move up by almost 10% in the past 12 months—and there is now a growing consensus that the rupee’s gains are not a temporary hop above the trend. So, unless the Reserve Bank of India (RBI) does something dramatic, either by erecting barriers against capital inflows or by intervening in the market to support the dollar, it is very likely that the rupee will hover around the 41 mark against the dollar in the months ahead.
Many corporate decisions over the next few months will be clouded by two likely assumptions that follow from the rise of the rupee—one pessimistic and the other optimistic. Each has to be taken with a pinch of salt.
The pessimistic assumption is fairly well known. A lot of the recent discussion and debate on the effects of a strong rupee has stirred fears that the rupee’s rising graph will puncture the profits of Indian exporters. At another level, there are the broader macroeconomic anxieties about an inevitable slowdown in overall export growth.
At a very crude level, it is often claimed that a 10% rise in the value of the rupee will inevitably erode the profit margins of exporters by 10%. This is not quite true. For example, many exporters use imported inputs to manufacture the goods that they export. The gems and jewellery sector is one obvious example. The sensitivity of exports in such sectors to a strong rupee is far less than is commonly assumed.
Neither is the simplistic macroeconomic conclusion beyond challenge. A strong rupee may harm overall export growth. But it may not. A lot depends on what happens to the nominal currency values and inflation levels in many other countries such as China. Also, the current debate completely ignores the role of productivity. The effects of a strong rupee on export competitiveness can be reduced if exporters learn to crank out more output from their existing resources. Discussing the future of export competitiveness by looking at just the nominal exchange rate is a futile exercise.
Then there is the optimistic assumption. A strong currency is a boon to those who have borrowed abroad, which right now means just about every company in India’s corporate A-list.
The latest foreign debt numbers show that at the end of December 2006, companies accounted for 36.4% of India’s total foreign debt of $142.7 billion. The government accounted for only 33.4%. This means that Indian companies collectively have more foreign debt on their books than the government has.
A rising rupee means that the cost of servicing this dollar debt may prove to be negligible. The borrower needs fewer rupees than before to pay off the borrowing. This will undoubtedly create an incentive for companies to go on a further global borrowing binge, thus increasing both leverage and foreign exchange risk. And this borrowing binge could lead to trouble if the rupee changes course, which is not completely implausible given the size of the current account deficit.
East Asia went through a dent-fuelled boom in the 1990s, culminating in the implosion of corporate balance sheets in 1997 when regional currencies plummeted.
Of course, a lot depends on how the foreign debt is structured. And the use it is put to. In general, companies that have natural hedges in the balance sheets—in terms of dollar cash flows from exports or international operations—have less reason to worry from higher dollar debts. The more strictly domestic companies should be more careful, however.
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