History has been unkind to Canute. The 10th century king of
England was so tired of his fawning courtiers that he took them
to the shore and commanded the waves to roll back. It was to be
a demonstration of the limitation of his powers. But Canute in
popular perception is the man who tried to turn the tide and
Reddy, the governor of the Reserve Bank of India (RBI), India's
central bank, face Canute's predicament. In the public mind, they seem to be trying to reverse an
inexorable inflow of dollars and its consequence -- an appreciating currency. Once traded at 47 or 48, the
rupee now hovers at 40 to the dollar. Observers call it the fastest appreciation of the Indian currency in
Is the rising rupee good or bad for India? What impact will it have on the global competitiveness of
Indian firms? Should the RBI or the Finance ministry intervene? Responding to these questions and
more, experts at Wharton and elsewhere say that the rupee's rise is the result of India's growing ability to
attract global capital. While this creates problems for some companies that earn most of their revenues in
dollars -- including IT giants such as Wipro, Infosys and TCS -- it also creates opportunities for Indian
firms by making it less expensive for them to acquire overseas assets. In addition, a strong rupee is good
for the Indian consumer. It would be unwise for the government to intervene to force down the rupee's
value, they note.
Dollars are pouring into India. Net investments by foreign institutional investors (FIIs) were $10.16
billion during January-June 2007. This is more than the $8 billion recorded in the whole of 2006. July
has beaten all records with an inflow of $5.81 billion (so far). The FIIs are chasing Indian stocks and
taking the markets to what many feel are levels of irrational exuberance. The bellwether Bombay Stock
Exchange (BSE) Sensitive Index (Sensex) was 15,732 on July 23 against 12,455 on April 2.
(Incidentally, that day's low -- the Sensex plunged 617 points during the day -- was caused by the RBI's
attempts to control the rupee.)
The foreign direct investment (FDI) numbers are equally impressive. In 2006-07, FDI inflows touched
$19.53 billion, a 153% increase over the previous year. (This figure includes private equity and also $3.5
billion in reinvested earnings.) The government is looking at a target of $30 billion in 2007-08. Foreign
exchange reserves stood at $214.84 billion on July 6. This is a far cry from $5.8 billion in the dire days of
March 1991, when India had to sell its gold to stave off a default crisis.
External commercial borrowings of Corporate India were $12.1 billion in April-December 2006, an
increase of 33%. Remittances from Indian workers abroad -- principally in the Gulf -- rose 15% to $19.6
billion in the same period. And non-resident Indian (NRI) deposits, attracted by better interest rates, were
also up 35% in 2006-07 to touch $3.8 billion. These foreign exchange inflows have pushed the exchange
rate to around Rs 40 to the dollar. The ru
Wharton finance professor Jeremy Siegel notes (in his podcast) that a rising currency can cause distress.
"This is painful. It's been the strongest appreciation of the rupee in over 30 years as I look back at some
of the data," he says. CEOs of IT companies would agree with that assessment. Speaking at a press
conference at Wipro's Bangalore headquarters on July 19, chairman Azim Premji complained about the
"strong headwinds faced by us in the form of the appreciating rupee." Wipro reckons that its operating
margins were lower by 2.4% in the first quarter because of the currency appreciation. Most IT companies
-- the poster-boys of India's economic liberalization -- are in the same boat; they have been unable to
meet their forecasted quarterly earnings. Their shares have been beaten down on the bourses, even as the
markets are hitting new peaks.
Infosys chief mentor N.R. Narayana Murthy notes, "It (the rupee rise) is a macro-economic issue. I am
not worried about factors which are out of my control." Others aren't taking it as easy. "A rising rupee
can have a large impact on Indian exports and it could erode our competitiveness in the global market,"
IT firm Satyam founder and chairman B. Ramalinga Raju told The Economic Times recently. "Countries
such as China are continuously suppressing the value of their currencies. So they may have an edge over
us.... The government should intervene to bail out exporters who have been hit by the strengthening
rupee." (The Indian government has announced a $3.5 billion package to provide relief to exporters in
several sectors. But that has been deemed by many as insufficient.)
"that rely on the U.S. market are clearly hurting. Companies such as Infosys and Wipro are feeling the impact, [but] smaller companies -- garment exporters and auto-part suppliers -- are hurting even more. Many of them banked on the dollar appreciating routinely after signing a contract. Now it is the other way around. I think these companies will be affected more than IT companies."
The Confederation of Indian Industry (CII) says that the worst hit are the textile and leather sectors.
While individual exporters and companies have their woes, some complain of damage at a macro-level.
A survey by the Federation of Indian Chambers of Commerce & Industry (FICCI) says sectors such as
automobiles, consumer durables, food and food processing, gems and jewelry, textiles, handicrafts, and
metal and metal products will be particularly impacted. "While the market should determine the
exchange rate in the long run, sharp fluctuations in the short term create problems of adjustment for
domestic industry," says FICCI president Y.K. Modi. The most affected, he says, is the small and
medium enterprises (SME) sector.
"My feeling is no, they should not intervene," says Siegel in his podcast. "My historical studies showed
that a lot of the 1997 crisis was because currencies did not appreciate. That was during the era of fixed
exchange rates in Thailand, Taiwan, Indonesia and the Philippines. And by not letting them appreciate,
they actually attracted more capital. By letting it appreciate, people are a little bit more cautious because
it looks a little more expensive now. And all of the capital that came in -- they couldn't deploy it
favorably, and the result was over-consumption, deficits and then finally devaluation."
"I think it is best not to interfere," agrees Wharton's Raju. "Some correction should take place by the end
of next year as U.S. expenditures outside decrease." Raju adds that in the short run, "A case can be made
to support the very small exporters. But the right way is to allow the rupees to flow out. Let Indians
invest in the U.S. -- not just companies, but also individuals. Some recent steps are in the right direction.
More can be done."
Montek Singh Ahluwalia, deputy chairman of India's Planning Commission and one of the principal
architects of the country's economic reforms, believes that the Reserve Bank and Finance ministry face a
difficult set of choices. In an interview in his New Delhi office, he told India Knowledge@Wharton that,
"This is a balancing act that the Reserve Bank and the Finance ministry have to play. It is a reflection
mainly of the trilemma that economists face; you can only have two out of three things. If you want to
have a stable currency, an independent monetary policy and capital account convertibility, you can't have
all three. You have to give up one."
According to Ahluwalia, "The positive feeling about the Indian economy is bringing in a lot of capital.
The only way you can absorb this capital is to let the exchange rate appreciate." He recognizes that
"many people feel the appreciation has gone beyond what is reasonable. But this is a balancing act. What
else can the Reserve Bank do? It can intervene to stabilize the nominal exchange rate, and that will
generate some liquidity. It can stabilize the liquidity, but that will impact the exchange rate. Whatever it
does, there will be some problem. What the Economic Advisory Council has said is that it can do these
three things, and it should do a little bit of each."
In an effort to force down the rupee's value, under normal circumstances, the RBI would have bought
dollars from the market. This releases rupees which the RBI then tries to mop up by issuing debt
instruments. But the RBI has bought some 28.4 billion in dollars between January and May 2007 and it
has to draw the line somewhere.
The sloshing liquidity leads to inflation, which is not politically palatable either. Indeed, the RBI sees
controlling inflation as its prime mandate. As measured by the wholesale price index, inflation has come
down to around 4.3% now, against 6.7% in January. But analysts warn that the trend may reverse soon.
The RBI has pulled out all the weapons in its armory. It has raised benchmark interest rates seven times
since October 2005. It has sought to suck liquidity out of the system by increasing the cash reserve ratio
(CRR), the amount banks have to keep with the central bank. Explains S.S. Tarapore, former deputy
governor of the RBI and the man who has prepared two roadmaps for the full convertibility of the rupee:
"While, until recently, the RBI has been intervening in the foreign exchange market buying dollars, the
resultant release of domestic liquidity has required the authorities to issue bonds under the Market
Stabilization Scheme (MSS), absorb liquidity under the Liquidity Adjustment Facility (LAF) through the
reverse repo facility (surplus liquidity in the market is placed with the RBI at a rate of interest of 6%) and
to increase the CRR. All this has costs. But these measures have increased interest rates in India and
stimulated even larger capital flows."
Economists and India's money mangers are divided on the virtues of a strong rupee and what the RBI
should be doing about it. "I have always argued that we should not intervene much on ups and downs of
exchange rates. Let market forces determine that," Satish C. Jha, economist and member of the Prime
Minister's economic advisory council, told The Economic Times recently. "We can't forget that the rupee
has remained undervalued for quite some time. I feel it will get stronger and will hover around 38 in the
next two years. We have seen a strong inflow of foreign capital into the market. How can we expect the
rupee to depreciate?"
The rupee will stay strong, says analyst Jamal Mecklai. Speaking to exporters at a seminar on "How to
deal with the new improved rupee," held in Mumbai recently, he said this was a period of churn. Big
export houses, he added, had weathered the storm because of their professionalism. The small companies
should similarly get their act together.
"It is obvious -- from the recent paroxysm in inflation followed by the trauma in the forex market -- that
control processes have run their course and, appearances notwithstanding, the Indian economy is being
run largely by the free flow of capital," wrote Mecklai in Business Standard. "The increasingly
aggressive bleating we are hearing about the strength of the rupee is clearly coming from sources that
don't recognize this."
"Exports are about job creation, not dollar creation," says Ajit Ranade, chief economist of the Aditya
Birla Group. "Unlike earlier, we are not starved of dollars." Ranade says you cannot compare the
situation in India with that prevailing in, say, the U.S. The so-called free markets in India are not free and
allowing market forces full play has atypical outcomes. "Look at our export-import basket," he says.
"Our three principal imports are crude, gems and jewelry, and capital goods. Crude prices are still
administered. And gems and jewelry and capital goods do not affect inflation. It would be different in the
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