A V Rajwade: Exchange rate, jobs and growth

WORLD MONEY

The current year is also likely to end with a strong surplus on the overall balance of payments (BoP), under both current and capital accounts.

The current account is in surplus and the capital account also looks strong with foreign institutional investor (FII) inflows having already crossed calendar 2003's record $ 6.6 billion. Private equity flows may get another $ 1 billion in the current year.

Besides, Indian companies have raised $ 2.12 billion in the first seven months of the year through issue of straight and convertible bonds, and equities.

To add to it, a significant sum has been raised by way of external commercial borrowings. Overall, a strong BoP can be expected, more so as the worst seems to be over for oil prices.

This is tempting many analysts to call for "letting the rupee go""" in other words, an appreciation of the currency. An edit in The Times of India said: "Go for growth: Don't fiddle with interest rates, let the rupee rise" (October 29). An investment banker, in his personal capacity, recently wrote in a financial daily asking the authorities with quasi-evangelical fervour, to "stop undervaluing the rupee...stop pandering to exporters".

Is the rupee undervalued? By my estimate, the current exchange rate of the rupee evidences no undervaluation, in REER terms (93-94 = 100). It could, of course, be argued that the REER does not fully reflect today's ground realities in terms of the competitiveness of the exchange rate: there is a surplus on current account of $ 1.9 billion in Q1 of 2004-05.

But the same RBI data discloses a deficit on merchandise trade of $ 6.3 billion. The commerce ministry's data discloses that the deficit has increased to $ 12.7 billion by September-end "" and this data does not include defence imports because they do not pass through customs.

We have recorded deficit on merchandise trade even when oil prices were much lower. Clearly, the argument that the rupee is undervalued is not supported by the data on merchandise trade.

To be sure, the rupee is undervalued in terms of services and it is the growth in services export (and inward remittances) that is resulting in significant invisibles surplus and a small one on current account. Should the undervaluation of the rupee in the services sector tempt us to allow it to appreciate?

To my mind, the answer to the question depends on the relative importance of the services export and manufacturing sectors to creation of jobs. We need to create anywhere from 8 to 10 million jobs a year, if only to keep social tensions from escalating.

Currently, the services export sector has created less than a million jobs directly; even if the sector grows to $ 50 billion by 2008-09, as projected, the number of jobs is not expected to amount to more than 2 million.

Even after factoring in the multiplier effect of the high paid jobs in the services export sector, one might guess at a figure of, say, 5 million or so direct and indirect jobs attributable to this sector by the end of the decade. It is obvious, therefore, that it is unrealistic to look at services exports for job creation on the required scale.

Direct employment in the services export sector has been broadly the province of the educated, highly qualified middle-class youth. It has not touched the much larger mass of less-educated youth coming in the job market, who need blue-collar jobs.

Moreover, living standards in the rural economy cannot improve unless at least a 100 million people get transferred to the manufacturing or non-rural, non-export services sectors. Again, domestic services will not grow except in tandem with the manufacturing sector.

Overall, to my mind, the importance of the manufacturing sector can be ignored only at our peril. And, in an era of free trade, at increasingly lower duties, the domestic manufacturing sector needs to be competitive not only in export markets, but also in the domestic market. The alleged undervaluation of the rupee needs to be looked at in this perspective.

A more proximate case is that of textiles with quotas scheduled to go from next year. We lost our chance of becoming a dominant player in world markets with our preference for the unorganised sector. China now occupies the position that could well have been ours.

But there is another opportunity now: not to displace China, but to register an increase in labour-intensive textile and garment exports to $ 25 billion or even $ 50 billion in the next few years. It would be sad to miss the bus again through a wrong exchange rate.

To come back to the investment banker, he has correctly argued that industry has coped with a fall in tariffs. But this was, at least, partly because of the exchange rate policy, which, therefore, needs to continue.

Again, much of the easier fruit in terms of productivity gains have already been picked, and further gains will be more difficult. If an appreciated currency is such a panacea, as he seems to believe, one wonders why Japan lost a decade of growth after ¥ 79 to a dollar, or why Argentina is bankrupt and offering 20 ¢ to a dollar on its bonds.

All evidence points that overvalued exchange rates are deflationary, cannot create investments, jobs or growth and often lead to crises. The Chinese who have the same concerns about employment growth as we, know this well "" and are resisting pressures to float the currency upwards, despite a far more competitive manufacturing sector and a huge trade surplus.

Email: avrco@vsnl.com