What Does Rupee Appreciation Mean for the Economy?

What Does Rupee Appreciation Mean for the Economy?

by M Rafeeque Ahmed*

Currencies appreciate when the economies are doing well and the rise in their values is a cause for celebration. The high value of the Deutsche Mark when Germany was the trendsetter for the world economy in the 1960s and the 1970s, the high value of the Yen in the 1980s when Japan Inc seemed set to take over the world, and the Dollar's high value in the later 1990s when the US new economy brooked no competition were sources of immense pride for the respective countries. An appreciating currency is the natural corollary of a booming economy with rising exports, and is normally looked upon favourably. Before we analyse the effect of the appreciating rupee on various segments of the Indian economy, let us examine the causes of the appreciation.

The causes for the rupee's appreciation after years of continuous depreciation are apparent. The current account surplus for the first time in years (it has since reversed), due to increased merchandise exports and invisibles, has resulted in supplies of foreign currency going up sharply. The huge FII inflows into financial asset markets (over $3.9 billion net inflows in the first 10 months of this fiscal), and increasing reliance on low cost foreign loans (the RBI has approved ECB borrowings to the tune of $1.7 billion in the April-June quarter alone) add to the supply, and help power the rupee higher.

The heartburn on the rupee's appreciation against the dollar is due to the fact that most of India's external trade is invoiced in dollars, and any change in the dollar's rupee value has a disproportionate effect on the various stakeholders in the rupee's external value such as importers, exporters, borrowers, lenders and consumers of imported goods.

Though exporters have seen their profit margins shrink, exports on the whole do not seem to have been affected seriously by the rupee's appreciation. The slowdown in exports in the past few years has been more due to global economic conditions than due to the rupee's rise. There is also no direct co-relationship between appreciation /depreciation of the rupee and fall/rise in exports.

Exports in dollar terms grew by an impressive 17.2 per cent in 1999-2000 when the rupee depreciated by 2.90 per cent. For the period 2000-01, when the rupee depreciated by 7.07 per cent, exports grew by a slow 1.7 per cent. In 2001-02, when the rupee depreciated by 4.78 per cent, exports crawled up 1.74 per cent. The trend continued in 2002-03. Contrary to expectations, however, exports registered their highest growth of 11.06 per cent in the April-June 2003 quarter when the rupee appreciated by a high 2.11 per cent.

Exporters are particularly perturbed by the fall in profits arising out of the recent surge of the rupee. The international buyer is not willing to pay to the exporter the extra price accruing from currency appreciation. The appreciation percentage has hence to be borne by the exporter which lowers his export proceeds, and erodes his profit margin. Firms find that their exports are being especially hurt as competitor countries with fixed currency, like China, are quoting very low prices for their goods thereby making the buyers switch over to such countries for purchases, resulting in loss of orders for Indian companies. Exporters also complain of incurring a loss between the period of invoicing and realization of export proceeds on account of rupee appreciation.

According to a survey conducted by some leading organisations, the strengthening of the rupee is particularly detrimental for the low import intensive and price sensitive terms such as textiles, leather and bulk commodities. The possible impact on some thrust segments of the services and goods exports sector could be thus:

Software exports (including ITES) accounted for an estimated 17.9% of the country's exports in 2003-04.

It may be mentioned that while the rupee has appreciated against the dollar, it has actually depreciated against the euro for the period between August 6, 2004 and December 1, 2004. It is important to note here the contribution of the US to the total revenues of software companies, which are dollar denominated.

For the software services companies in India, 85-90% billing is in US dollars. Therefore, the recent rupee appreciation will have a negative impact on the software sector. The magnitude of impact is likely to differ for companies. Many software services companies have hedged themselves against the dollar for the next twelve months, and to that extent, the impact is mitigated. The new contracts that are likely to be signed will factor in this rupee appreciation, and to that extent, there will be a negative impact.

The rising rupee is expected to dent realisations of the Indian textile industry in the current financial year. Textiles, including garments, forms a major part (about 19%) of the export basket and is one of the main contributors to the forex kitty. A one per cent rise in the rupee would lead to a decline in profitability by 1.2 per cent, textile industry sources say. Therefore, on an average, 6.45 per cent of the export earning is being affected due to appreciation of the rupee. Garment exports grew by only 1.25% in April 2004, whereas the textile sector showed a marginal growth of 4.5% in the same period.

Leather is also a price sensitive sector, particularly finished leather, leather components and travel goods. In shoes and garments, the industry is moving up the value chain and, therefore, is able to absorb the appreciation. However, the sector as a whole was affected, and showed a growth of only 6.06% in April 2004.

The gems and jewellery industry remains unaffected by the rising rupee. The diamond industry has more than 90% import intensity and rupee appreciation has considerably reduced the cost of their inputs. The increase in demand on the contrary led to 52% growth in April 2004, as compared to the corresponding period in 2003

The auto ancillary sector has been one of the biggest drivers of export earnings in recent years. About 15-20 per cent of the total auto component production is exported. However, only 30 per cent of the billing in the auto ancillary sector is dollar-denominated. For some big companies, almost all their billing is euro-denominated and the rupee has remained weak when compared with the euro. So, the impact of the rising rupee has been cushioned to that extent.

The biggest beneficiaries from rupee appreciation are importers, as the dollar is now worth less for every rupee or, to put it in different terms, less rupees can buy more dollar-denominated assets / commodities / goods. Companies that source raw materials from the global markets and are largely domestic demand driven can potentially witness margin improvement.

The Indian consumer is a big beneficiary too, as costs of a host of imported goods - from petro products to electronic, electrical and consumer items - would be higher, but for the rupee's appreciation. The rupee's appreciation is one of the reasons for the current low inflation rate.

The weakening dollar is bringing in money into the country, which is likely to be short term, because once the US raises interest rates again (which is more likely), the India story might fade away, and the current strength being witnessed on the back of strong FII inflows will weaken.

In this era of globalisation, a stronger rupee would also mean that Indian companies can now acquire overseas assets at a lower cost. Indian companies going abroad to acquire foreign companies should find the going better as the rupee gains. This should make overseas acquisitions attractive for domestic companies.

courtesy:http://www.fieo.com/fieonews/2005/january/ahmed.html