Surjit S Bhalla: Rupee rise - Advantage China

NO PROOF REQUIRED

India's policy of rupee appreciation has had the unfortunate, and predictable, effects of not only hurting the Indian economy but also benefiting the Chinese economy.

A favorite in cocktail circuits (but after the French president and the US elections) is the value of the rupee. Passions run high, as do explanations and forecasts. But all assessments reveal the pocketbook. In one camp are those who have profited handsomely "" foreign investment banks, domestic firms who had the good fortune to borrow in dollars made cheaper by the rupee rise, and economists who believe that there are large gains to the economy with a rise of the rupee. In the loser's camp are not only large job losses in the export industries but also a general slowdown of the Indian economy. All this before the slowdown in the developed world begins to hurt Indian growth.

There is no question that the decision to advance the rupee by a whopping 9 per cent in one month (mid-March to mid-April 2007) was made at the highest levels of government "" the Congress party, the Prime Minister, the Finance Minister and the RBI Governor must have been involved. The policy parlour game is about who was the 'culprit'. The finger of suspicion generally points to the Congress party and the Finance Minister "" the belief is that the Congress was so upset about losing elections that they started looking for excuses beyond their own incompetence and settled on inflation. Then some crude calculations were made about the likely impact of the rupee appreciation on inflation. For an answer, just look at the oil bill and the rising share of trade in the Indian economy. At 25 per cent share of trade in GDP, a 13 per cent appreciation of the rupee would lead to a more than 3 percentage point decline in the inflation rate. "Let's do it," was the Congress war cry. 
 

Evolution of Exchange Rates, India-China, 2000-2007
Year	Nominal Exchange Rate		Real Exchange Rate (bilateral US$)		Real Effective Exchange Rate (multilateral)
	India Rs/$	China Yuan/$	India	China	India	China
2000	44.9	8.3	100.0	100.0	100.0	100.0
2001	47.2	8.3	95.8	100.1	101.6	104.3
2002	48.6	8.3	95.1	98.2	99.6	101.9
2003	46.5	8.3	101.2	99.1	99.7	95.2
2004	45.3	8.3	105.5	103.1	100.4	92.7
2005	44.1	8.2	109.8	104.9	102.9	92.5
2006	45.2	8.0	110.9	106.8	99.4	94.4
2007	41.2	7.6	125.8	116.5	105.5	98.8
2008*	39.3*	7.2*	131.9**	122.1**	108.6**	101.3**
Notes: 1) All values are for averages for calendar years except those with an asterisk 2) * indicates value for mid-Jan 2008; ** are extrapolations

But there may be just a few more people who should be involved in the blame game, in particular, those who wrongly suggested that the Indian economy was in 'overheated' mode. Distinguished policy makers were in this club, mostly populated by former and present leaders of the RBI. This confluence of interests must have been too much for those who said that the appreciation of the rupee had little economic or political logic to recommend it; hence, the policy decision to significantly appreciate the rupee.

Almost a year has passed since the exchange rate change; and it is time to consider whether the appreciation of the rupee has delivered on its promise. First, the all-important decline in the inflation rate "" it is today at around a 3 per cent rate versus a 6 per cent plus rate before the exchange rate change. Seems like a perfect result for those advocating appreciation. Except for a slight problem "" inflation is a function of several factors, but as pointed out in early March ("Inflation "" An Ex-Problem?", Business Standard, March 3, 2007), the seasonally adjusted six-month inflation rate was already down to 3 per cent! So, as expected, zero value was added by the much-hyped policy of appreciation of the exchange rate to control inflation caused by supply side shortages of food!

But there is a new twist introduced by those arguing for rupee appreciation. It is that Asia has to play its role in correcting global imbalances and, therefore, India has to appreciate its currency along with China, Korea, Malaysia, Singapore etc. Why that has to be so is unclear, especially given the fact that most of our East Asian neighbours have current account surpluses (CAS), while India has a current account deficit of around 3 per cent of GDP. China has a CAS of 13 per cent of GDP, the largest ever recorded by a non-oil exporter. So, based on fundamentals, while it is understood that China should let the yuan appreciate, why should the Indian rupee, given the fundamentals, not depreciate?

The table documents the trend in the real exchange rate (the one that matters for competitiveness, and jobs, and economic growth). Two real exchange rates are reported for each country: The first is the rate with just the US dollar, and the second is a trade-weighted exchange rate (IMF for China and RBI for India). According to the bilateral real rate, India has lost about 10 per cent in competitiveness to super-competitive large trade surplus China. This holds regardless of the starting date "" 2000, 2004, 2005, or 2006.

The IMF real trade-weighted exchange rate for China shows a depreciation of one per cent since 2000, in contrast to a 5.5 per cent appreciation for India. Since 2005, the Chinese yuan has had a marginally higher appreciation rate, and the reverse is true for India for 2006. Prior to 2007, India had the same real trade-weighted exchange rate in 2006 as in 2000; China's RER was 5 per cent lower ( these numbers compare the value for 2007 related to earlier years). This gives some indication of the under-valuation of the Chinese yuan. Comparing today (mid-January 2008) to 2000, India shows a 9 per cent appreciation, China shows a 1 per cent appreciation. Thus, regardless of pyrotechnics involved with 'dating' the appreciation episodes, the fact remains that India has lost competitiveness with respect to China.

In this globalised, integrated, razor-thin competitive world, exchange rate policy matters, and our policy makers should realise that they cannot take arm-chair explanations of politicians and journalists (yes, and even economists) as indicative of what matters in the real world. Our hasty, ill-thought-out exchange rate policy has given a major advantage to our competitors, especially China. It is commonly believed that the only beneficiaries of the Left's opposition to India's nuclear policy are our political competitors, Pakistan and China. Equivalently, the major beneficiary of our exchange rate policy is our economic competitor, China. Perhaps inadvertently, the Congress (and the RBI?) has done the same damage to economic India as the Left is willing to inflict on political India.

The author is Chairman and Managing partner, Oxus Investments, a New Delhi-based asset management company.

surjit.bhalla@oxusinvestments.com