A V Rajwade: 'Exchanging' jobs

WORLD MONEY

If two million jobs can be lost due to the rupee appreciating, macro-policy just has to address this.

Last Monday, the commerce minister informed Parliament that job losses in the export sector could be as high as two million, primarily because, at the current exchange rate, Indian goods are not competitive. Articles and editorials in media have also commented on the issue. I have consistently argued against an overvalued exchange rate, in the interest of investment, growth and employment creation which, to my mind, need to remain the primary objectives of macro-economic policies.

Many people in authority are advising exporters to adjust to the strong rupee: exporters are, of course, doing so and this has been reflected in the layoffs referred to by the commerce minister. The other response is that many companies are planning to start units in more competitive environments like China and Vietnam. The exchange rate policy is thus promoting investment and job creation abroad.

Several myths are being propagated on the subject, that:

Exports are not important to growth. The truth is that in 2006-07, export growth accounted for more than 40 per cent of the GDP growth.

Our growth is domestic demand-led and, therefore, the exchange rate is not a very important macro-variable. The truth is that, with an uncompetitive exchange rate, domestic demand will fuel imports, rather than growth in domestic output. Car manufacturers, for example, are switching from domestic suppliers of components to imports.

Import-intensive exports benefit from a stronger rupee. In recent weeks one has seen CRISIL economists and other academics (ET, Dec 10) making the point. The reality is that any business is established to add value, for which it incurs costs like wages, power, and so on. In export industries, the value added is effectively in dollar terms, while the costs are in rupees. To the extent the rupee appreciates, the rupee equivalent of the value added is inadequate to meet the rupee costs. In the case of diamond exports, for example, rough diamond imports are perhaps 70-75 per cent of the export value. The lower cost of imports does not improve the economics at all since the appreciated rupee reduces export realisations by more than the cost "saving" on exports.

SMEs should index (ET, Nov 23) part of the wage costs to the exchange rate. This seems to be utterly unrealistic.

As for intervening in the exchange market, some argue that "intervention is not only unnecessary; it is ineffective" (Roman Frydman and Michael Goldberg, ET, Nov 17), given the market size. This argument does not seem very convincing: central banks become effective more through changing expectations than as a direct impact of interventions either in the money or exchange markets. While on the subject, I find the difference between some analysts' stance on the domestic and external values of money to be difficult to understand. It is universally accepted that the primary duty of a central bank is to protect the domestic purchasing power of the currency, by keeping inflation under control. For this purpose, they intervene in the money market by targeting either the cost of money (that is, interest rates) or the quantity of money (that is, money supply). If maintaining the domestic value of the currency and intervening in the market in pursuit of the objective is legitimate, I do not understand why the external value is considered too holy and, therefore, not to be polluted by central bank intervention "" when, in a rapidly globalising economy, the external value is so important to growth and employment.

To my mind, no amount of "sops" will work. The continuation of the existing policy will damage more and more the economy's capacity to create jobs and we should not fool ourselves otherwise.

Complex Derivatives
As regular readers of my column would recall, I have been a consistent critic of complex, structured derivative products marketed in India to relatively unsophisticated customers, who too often did not understand the implications, let alone the reasonability of the pricing, of these products. As Lord Charles Aldington of Deutsche Bank UK said about some German investors in credit derivatives, "it is not clear that the investors fully understand what they were buying" (Financial Times, Dec 5), this is true in spades of Indian companies-marketed fiendishly complex products.

But, as a student of derivatives market, I believe that the suitability and appropriateness, and regulatory compliance, of many of these transactions, are key issues. To end the article, here is a quote from Nobel Laureate Paul Samuelson: "As one of the economists who helped create today's newfangled securities, I must plead guilty: these new mechanisms both mask transparency and tempt to rash over-leveraging." (International Herald Tribune, Nov 19)

avrajwade@gmail.com