Focus on productivity

The ministry of commerce and industry and the money of finance worked out an arrangement last week to offset the impact of the steadily rising rupee on export competitiveness. This mainly consists of an enhancement of the duty drawback allowance, which helps exporters offset the impact of domestic taxes on their costs, and a reduction in the interest rate on credit. The whole package is expected to cost Rs. 1,400 crore. Against the backdrop of total exports in the region of $125 billion (Rs 5,00,000 crore) and a rise in the rupee's exchange rate vis-à-vis the US dollar by about 8 per cent over the past few months, this appears like a drop in the ocean. It is difficult to visualise how this little tinkering with the incentive regime will come anywhere close to counteracting the effects of appreciation on exporters' rupee revenues. It appears to be much more a matter of needing to be seen to be doing something.

With exporters accusing the government of betraying them by allowing the rupee to appreciate so sharply, it was almost inevitable that something would be done to appease them. Taking the rupee back to a level which exporters had become comfortable with, would certainly have been considered, but this is almost impossible. In a situation of structural balance of payments surpluses, the natural tendency of the domestic currency is to appreciate, because the supply of foreign exchange exceeds the domestic demand for it. Managing the exchange rate is possible, as India and the rest of Asia have demonstrated, but unless something changes on the balance of payments front, once the currency is let go, there is no bringing it back. It can, at best, be stabilised at a higher level, which means that, everything else remaining the same, exporters have to take the hit of the appreciation until they are able to offset it with increases in productivity, which will bring their unit costs down.

Productivity increases are the only sustainable way to deal with a long-term currency appreciation scenario, which is what India seems to be in today. Most of the country's major exports are from sectors in which productivity is closely linked to scale. Small-scale reservation was a major barrier to achieving efficient scales; however, even as that is steadily being done away with, other constraints remain, such as the imposition of job security regulations on larger establishments. Nor is the push towards special economic zones going to ease the pressure; the same laws will continue to apply and it will prove to be a huge political and legal challenge to provide the exemptions that some states have promised. China is often cited as an example of the benefits of keeping the exchange rate undervalued, but the emphasis on the exchange rate often causes analysts to lose sight of the significant cost advantages that Chinese exporters have over India's simply as a result of much larger scales of production. Given the long-term prospect of continuing rupee appreciation, sops such as the ones announced last week turn attention away from the fundamental issues of productivity and cost efficiency. The ministry of commerce and industry would be doing its constituency of exporters a much greater service if it were to focus on these fundamentals and collaborate with other ministries to drive improvements in them.