There were reports recently that the minister of state for commerce and industry, Nirmala Sitharaman, had sought a meeting with the finance minister to discuss the rupee’s external value. The reports were subsequently denied, but it is no secret that Ms Sitharaman thinks the rupee is over-valued and acting as a constraint on exports. The Reserve Bank’s calculations show that the rupee is indeed over-valued from a trade perspective. But Ms Sitharaman got no joy from the previous Reserve Bank governor, Raghuram Rajan, who once advocated that “grumblings” by exporters should be ignored, and the market left to settle the rupee’s value. This essentially hands-off position needs review because of the unusual structure of India’s trade.
The problem faced by Indian exporters (by which is usually meant exporters of goods) is that their counterparts who export services have been supremely successful. So, while India has a massive deficit when it comes to trade in goods (imports last year were almost 50 per cent higher than exports), it has a surplus when it comes to trade in services. The trade deficit for goods has been as high as 6-7 per cent of GDP in recent years. A country with such a high trade deficit would ordinarily be seen as uncompetitive, and its currency would weaken, thereby creating an environment for more balanced trade. However, the net deficit on the current account, taking trade in both goods and services, as also remittance inflows, is a nominal 1 per cent of GDP—and even that is more than made up through capital inflows. India therefore has a net surplus of dollars each year. Result: there is no downward market pressure on the rupee, whose high value remains a handicap for goods exporters.
No advanced, post-industrial society would think it is a problem if its trade in goods is in deficit, provided its over-all external account is in balance. However, a country at India’s stage of development needs to focus on goods export for a variety of reasons. Surplus labour in agriculture needs to be absorbed in employment-intensive industry (as China has done). Also, goods exports have greater linkages with the rest of the economy, and therefore greater spread effects, than the export of services in fields like information technology. For these and other reasons, India needs to worry about goods exports doing well.
Inevitably, then, if the RBI adopts a hands-off policy on the rupee, the commerce minister becomes a very unhappy person. Her efforts to counter-act worsening trade balances with virtually every country with whom India has signed a free trade agreement, will bear no fruit if the rupee continues to rule too high for goods exporters to compete. To put it crudely, the success of TCS and Infosys is killing exporters of garments and other manufactured products. An over-valued currency also makes imports cheaper, forcing the country to adopt defensive measures on agricultural items, and to counter-act steel imports. Such defensive measures would be unnecessary with better currency alignment. With a proper currency rate, Indian agriculture would be more competitive and (with supportive measures) could deliver substantial export growth.
Is there a way to engineer a better currency alignment? Yes, there is. The Reserve Bank could adopt a more interventionist policy in the currency market, by buying dollars which consequently would go up in value against the rupee. RBI could also make less open the window for foreign borrowings, so that debt inflows get constricted. Note that external commercial borrowings had trebled in six years (at a time when domestic credit grew slowly). If both measures are taken in moderation, and calibrated such as to prevent shocks in the market, the results would be wholly beneficial. By altering the supply-demand balance for dollars, these twin policy initiatives would push down the rupee.
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