Is the rupee correctly valued?

DEBATE

While the rupee is getting stronger by the day, the question is really about how it has behaved vis-a-vis competing currencies.

BHARAT BANKA,
President, Group Finance
Aditya Birla Group

The rupee's rise has been sharp, but it is less than that of other BRIC nations, and the yuan is all set to appreciate between 2.5-4% now

On the face of things, the rupee does look overvalued. It has appreciated 6.5 per cent since the beginning of the year and trades in the 40.6-41.5 range. The degree of the appreciation, though not the fact of the appreciation per se, has shocked the market since the conventional wisdom is that the RBI steps in to intervene at each rise, to prevent the rupee from appreciating too much as this lowers export competitiveness. This is a level the rupee has not seen since May 1998. Even earlier, it was only in 1996 that we saw such an appreciation, and at that time it was 5.7 per cent. Since the trade-weighted real exchange rate (REER) stood at 107.91 in March 2007 as compared to 104.12 in April 2006, the rupee looks overvalued, by around 6-7 per cent. By this reckoning, of course, even real interest rates look quite high, but no expert is betting on their easing off as yet!

Whatever story the REER may tell, the rupee looks all set to appreciate even further since the major reason for this is foreign exchange inflows and the attractiveness of the Indian economy. While the balance of payments surplus was $2.27 billion in July-September 2006-07, this rose to a whopping $7.5 billion in the October-December 2006-07 quarter.

The RBI's task is not an easy one since it has to juggle with multiple balls at the same time and try to strike a balance. On the one hand, it has to tackle rising inflation and on the other, it has to deal with rising interest rates. It has to balance liquidity on the one hand and manage GDP growth on the other ... the list is endless.

The RBI has stepped in to try and make inflows a bit less attractive. It has, for instance, reduced the interest rate on NRI deposits and has plugged the preference share route by saying that such inflows will be classified as ECBs, and investments in the real estate sector have been made more difficult by increasing risk-weighting and other means.

Yet, the Indian real estate market has not delivered, for instance, even a tenth of the appreciation the Hong Kong one did, so there is still a lot of scope for more inflows in just this sector. Today, whatever the RBI may do, there are enough vehicles around, such as Contract for Difference (CFD) through which money will come in, whatever the policy may be.

The only way the rupee can stop appreciating is if inflows slow down, say, if the RBI increases interest rates dramatically to slow down the growth momentum. But such a move cannot be applied selectively; it has to be applied across the board and that cannot happen since part of the RBI's job is also to ensure the economy doesn't slip off track completely.

The other issue worth keeping in mind is the rupee's behaviour vis-à-vis other competing countries. When it comes to the BRIC nations, and let us leave China for the time being, the appreciation is less than that of either Brazil or Russia. In any case, with the yuan not moving and the international pressure to revalue increasing by the day, you can expect an appreciation of anywhere between 2.5 and 4 per cent "" the exact amount and the number of tranches over which this will happen are matters of detail. In which case, there is every reason to expect the rupee to appreciate further. No matter what economists or exporters may like, the rupee will keep appreciating till capital inflows ease and inflation reaches the more acceptable target set internally by the central bank.

In the meanwhile, one can expect more tightening of capital inflows in the real estate sector, stricter interpretation of ceilings on foreign investment where applicable and more liberal measures on Indians expending dollars, a move towards what's called 'fuller convertibility'. The upward risk to my analysis is an unprecedented rise in winter harvest that improves the supply side drastically and changes the inflation outlook equally dramatically; and secondly, an increased number of stringent regulatory interventions that artificially make things look better than they are in reality!

SANJAY BHATIA,
President
PHDCCI

The US' large current account deficit will ensure the dollar continues to depreciate "" we are advocating hedging to protect against this

The steady appreciation of the Indian currency against the US Greenback has put the exporters in a tight spot. A recent survey undertaken by the PHDCCI has found that a majority of the respondents have been hit due to a sharp dip in their rupee realisation. The appreciation has been to the extent of 10-12 per cent over the last year.

Ninety per cent of India's exports are dollar denominated. The worrying factor is that in spite of being overvalued, this trend would continue in future as well. The most affected segments of exports are price-elastic goods, where a slight movement in the exchange rate can crowd out Indian exports. As a thumb rule, 45-50 per cent of merchandise and invisibles exports from India are price sensitive such as textiles, infotech, leather, tea, spices and marine products exports.

Indications are that the dollar which is perceived to be kept at a higher level will show sluggishness in future as well. US exports have shown buoyancy since the dollar has depreciated against major currencies.

Equally significant is the cut in the US import bill, particularly against Japan and China. The prospects for reducing the huge current account deficit, which the US has accumulated over the years, may force that country to depreciate the currency further.

In order to insulate the exporters from the vagaries of currency fluctuations, the government should take some measures. Inflation management is showing some positive results and inflation is expected to come down in the coming three to four months.

This would help the RBI to bring down the rate of interest, which will have two positive spin-offs on exporters. First, the cost of export finance will come down, which is currently ruling at 8-9 per cent. Also, lower inflation translated into lower domestic prices will help the exporters to source the inputs, intermediates and finished products at a lower cost, partly compensating for the erosion in export realisation.

Another recent survey has found that an increasing number of exporters are reducing their dollar exposures in export transactions and are switching over to other currencies such as yen, euro and pound. It is expected that more and more exporters would follow this trend and book their transactions against the basket of currencies. The government should also book the foreign exchange reserves in other currencies in view of the steadily declining dollar.

India Inc has been advocating the exporting community to take forward cover to hedge against currency fluctuations. Presently, only large exporters are going for forward cover. We are embarking on a high decibel export cover advocacy, mainly targeted at the small and medium enterprises to ward off future currency shocks.

Information technology exports from the country have risen several folds during the last few years. There are close to 5,000 IT firms in the country. Barring a few big names, the rest of the players are in the small and medium segments. Their exports are in small volumes. Their margins have already come under great strain.

If the dollar continues to rise, many of them apprehend that they would be out of business soon, given that more than 60 per cent of India's IT exports are US-centric. It is time the government promoted 'internal wiring and digitisation' of domestic industry like what has been going on in China, to find alternative channels of business for small IT exporters.

A devalued dollar is expected to help the imports, particularly capital goods and oil. But this may be a short-run phenomenon because of two reasons. First, lower export realisation for the companies would affect their capability to import. Secondly, in future an increasing number of imports are going to be denominated in currencies other than the dollar, denying the so called 'import dividend' on account of a falling dollar.

(The views are personal)