Active Stocks
Thu Mar 28 2024 15:59:33
  1. Tata Steel share price
  2. 155.90 2.00%
  1. ICICI Bank share price
  2. 1,095.75 1.08%
  1. HDFC Bank share price
  2. 1,448.20 0.52%
  1. ITC share price
  2. 428.55 0.13%
  1. Power Grid Corporation Of India share price
  2. 277.05 2.21%
Business News/ Opinion / Online-views/  Trade policy and exports
BackBack

Trade policy and exports

It is surprising that the crucial relevance of the exchange rate to foreign trade does not seem to be getting enough attention from policymakers

Photo: BloombergPremium
Photo: Bloomberg

Recently, the commerce ministry announced a much delayed foreign trade policy for the next five years. While the procedural simplifications are to be welcomed, I am intrigued by some of the numbers. In an interview to Mint on 2 April, commerce secretary Rajeev Kher said while the ministry has not yet worked out the current year’s target, “we have worked out the five-year target, we have worked out the merchandise service combined target of $900 billion at the end of 2020… While working out the compound annual growth rate (CAGR) for the five-year target, we have worked on a CAGR of 14%".

While the arithmetic is fine, is the assumption of 14% CAGR reasonable? Two points strike me—the actual CAGR has been just 2.1% a year over the past three years, and whether it is reasonable to expect an increase to 14% for five years on past performance, whatever the sops, subventions, subsidies or the (unquantifiable) benefits of procedural simplifications are in the policy?

Although simplified procedures do help, are the other subventions meaningful? The policy seems to increase the subventions for special economic zones by 3,500 crore; exports from these tax-free enclaves amounted to 4.9 trillion in 2013-14. The former amounts to less than 0.7%, or say 0.4 per dollar. The interest subsidy comes to 1,625 crore and is irrelevant for the economics of exports of $450 billion a year, particularly when the rupee is overvalued by 25% in real terms, by 15 per dollar.

It is surprising that the crucial relevance of the exchange rate to foreign trade does not seem to be getting enough attention from policymakers, or even businesses. While firms lobby strongly for lower interest rates, higher duties on imports and regulatory simplifications, they are silent on the issue of the uneconomic exchange rate. This is in sharp contrast to their counterparts in the euro zone, who have welcomed the fall of the euro even as US business profits are getting squeezed by the dollar’s appreciation.

To be sure, recent reports suggest policymakers in Delhi are getting concerned about “the strong rupee… hurting the nation’s merchandise exports" and feel that “a cut in interest rates will weaken the rupee" (The Economic Times, 1 April). For one thing, a strong rupee also hurts exports of services and, equally, units making in India who have to face competition from imports. Again, the largest increase in portfolio flows into India over 2014-15 has come in debt securities rather than in the equity market ($28 billion compared with $18 billion).

My feeling is that much of the money in debt securities has come in anticipation of further rate cuts. Given the inverse relationship between bond yields and prices, the capital gains are more attractive than the carry trade that plays on interest differentials. Policymakers should not overlook that as well. Lower interest rates are, in any case, a bullish factor for equity prices. Overall, we could end up with higher inflows of portfolio capital by lowering interest rates.

If they are serious about lowering the rupee, which I think they should, the only reliable way is for the central bank to intervene directly in the market, exactly what the Swiss central bank was doing to keep the Swiss franc from appreciating against the euro beyond CHF 1.20. It recently abandoned the effort, and the franc has soared to CHF 1.05 despite negative interest rates.

The question of intervention by the central bank raises two issues.

Firstly, the sterilization of money supply resulting from intervention has a cost, since it means replacing higher interest rupee assets on the central bank’s books with lower interest foreign currency reserves. This is a narrow way of looking at the economic impact of intervention and sterilization. The cost of an overvalued rupee, in terms of loss of potential output, growth and unemployment, is far higher than the cost of sterilization.

Secondly, an overvalued rupee is useful for the Reserve Bank of India’s preferred single-point agenda of targeting inflation, forgetting the impact of disinflationary measures such as high interest rates and an overvalued currency on growth and employment. It is a myth that low and stable inflation is a necessary, let alone sufficient, condition for rapid growth of an economy. Interestingly, its US counterpart is worried about the impact of the appreciated dollar on job growth.

A related issue is whether we should target a particular level of reserves, as some argue. In my view, this is a way of putting the cart before the proverbial horse. Targeting a real exchange rate is the independent variable, and the level of reserves is the dependent one.

In a recent article (Business Standard, 4 April), T.C.A. Srinivasa Raghavan wrote, “Mr. Modi is fascinated by the way China runs its economy". If he is serious about the Make in India initiative, about the trade policy goal of doubling exports in five years, he should tell his central bank to follow China’s exchange rate policy.

A rupee overvalued by 25% will not achieve it. Whether the paper on which currency notes are printed is made in India or imported (a point he made in his interaction with the central bank last week) is irrelevant to the big picture.

A.V. Rajwade is a risk management consultant, columnist and author. Respond to this column at feedback@livemint.com

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 09 Apr 2015, 12:12 AM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App