The myths we propagate

WORLD MONEY

As the rupee appreciated sharply against the dollar, one came across some interesting myths. Consider some:

• On March 26, Business Standard highlighted on the front page ("Market alone decides Re movement: RBI"), the winners and losers. The first winner cited was "Sectors like gems and jewellery, which are import driven".

While these sectors do use imported gold and rough diamonds, much of the output is exported. In fact, so-called diamond exports is one of the largest segments in our export basket "" "so-called" because what we really export is not diamonds but the services of the cutters and polishers.

In this business, to the extent of the import content, the exchange rate is irrelevant; it is relevant only for the value added. (Even domestically, gold ornaments are priced at cost of metal plus labour charges.)

And, a rupee appreciation reduces the value added in rupee terms and will squeeze the workers' wages. The sector is clearly a loser, rather than a winner, more so because today it is probably using diamonds that had been imported when the exchange rate was higher, and the export will now fetch a fewer rupees.

The "5 per cent of India's exporters who have shifted to euro invoicing" have also been classified as winners. For a given EUR: USD exchange rate, their rupee realisations are reduced by the rupee's appreciation against the dollar.

They may not be feeling the pinch on margins as much as the dollar exporters because the euro has appreciated against the dollar. But this does not make them "winners" from rupee appreciation.

Chief economic adviser Ashok Lahiri was quoted elsewhere on March 30, as saying that "he did not see the rising rupee hurting the country's exports, which surged 35 per cent in February compared to the same month a year ago, despite the rupee's rise against the dollar."

Lahiri knows as well as anybody that exchange rates affect trade flows with a lag of anywhere up to 12 months; that, until recently, in real effective terms, the rupee had not appreciated; and now that it has, chances are that the impact will be felt after a lag.

Who are we trying to fool by arguing, in effect, that the exchange rate is irrelevant to exports? If the higher interest rate on rupee export credit (say 7.5 per cent) makes exports uncompetitive, as is claimed, the impact of exchange rate change is 4 per cent in the last couple of weeks alone: in contrast, if the interest rate is halved, this would at best reduce costs by 1 per cent!

On March 29, Finance Secretary D C Gupta said the market stabilisation scheme (MSS) "will not affect the fiscal deficit of the Centre. It will only sterilise the high build-up of forex reserves." The fact is that MSS will affect the deficit as compared to what it would have been in its absence.

That's because the money raised will remain to the credit of the Government of India, but not available for use or earning interest, even as interest is accruing on the bonds sold. The point is whether the financial and economic costs of non-intervention or non-sterilisation would be higher; to my mind, they will be.

The Reserve Bank of India's (RBI's) "intervention policy of putting a floor under the dollar was giving a free ride to speculators". To me, this argument is completely wrong. All speculators in the dollar: rupee exchange market, by far the largest being Indian companies and banks, have been shorting the dollar in the hope of its fall.

Therefore, the RBI's putting a floor under the dollar by buying dollars in the market, deterred, rather than encouraged, speculation! In fact, the short dollar players have made much more money in the last week after the RBI stopped supporting the dollar.

"If Japan continues to register surpluses even after the exchange rate has tripled, why should we worry about a mere 12 per cent appreciation of the rupee against the dollar over the last couple of years?"

It has been forgotten that Japan's formidable export machine was built on the foundation of a significantly-undervalued exchange rate for a quarter-century after the end of World War II. During this period, exports moved from commodities like textiles to brands like Sony and Toyota.

And the price competitiveness of brand-name products and price-led commodities is quite different. As of now, we are far from export of branded products.

"We need not be unduly concerned about manufactured goods exports as our services exports are very competitive even if the rupee appreciates further." First, the margins in a number of low-tech services exports, such as call centres, are thin, and their growth will depend on the exchange rate.

Second, a rising rupee would clearly persuade our diamond exporters to shift operations to Thailand, and our manufacturing industry to China, rather than investing here, exactly what Sony and Toyota have done!

Moreover, what is often overlooked is that the exchange rate affects not just exporters; the value added in many major industries, such as steel, nonferrous metals, petro-chemicals and so on, and pricing on import-parity basis will also be squeezed.

Let us not get carried away by the myths being propagated: the exchange rate is too important a macro-economic variable to be trifled with. Much of the rise in reserves is due to inflows of short-term capital like leads and lags, foreign institutional investors and so on.

We suffered for decades from an overvalued exchange rate. Let us not fall into that trap again by mistaking swelling for muscle.

E-mail: avrco@vsnl.com