The trauma of the 1966 devaluation has so imprinted itself on our national consciousness that we dread any news of a fall in the value of the rupee. The devaluation is alleged to have led to many problems, including inflation and the economic slowdown of that year. The devaluation of 1966 resulted from serious balance of payments problems, in the wake of a severe drought and an India-Pakistan war. With foreign exchange reserves at an all-time low, we were at the mercy of multilateral institutions and the United States of America.
The gurus of Brettonwoods had counselled us to devalue earlier. T.T. Krishnamachari, who was finance minister then, had stuck to his stance against the ideologues of the World Bank. He even declared the adviser of the International Bank for Reconstruction and Development at the time, persona non grata. His reluctance to devalue led to lobbying against his continuance and finally forced his resignation, albeit ostensibly for other causes. India has gone places after that episode. Today, we are faced with the reverse phenomenon — the rupee rising as forex floods the reserves of the Reserve Bank of India.
The rupee has risen nearly 10 per cent in the last year. This has primarily reflected the excess inflow of dollars, mostly due to capital inflows by foreign institutional investors and foreign direct investments, and also the increased inflow of remittances and software earnings. The turn in our fortunes since the economy opened up in 1991 has been remarkable. Forex is attracted by increased industrial opportunities as well as by other chances to turn a profit. The growth of business process outsourcing has added yet more strength to our BoP. The rising forex inflows necessarily mean that there is enough, and more, dollars to meet our demands for imports. Excess supply drives the value of the dollar downward in relation to the rupee. A cheaper dollar means the rupee rises.
The RBI has resorted to a series of operations to control the rise of the rupee. A strong rupee is bad for exports and makes our exports costlier in terms of dollars. Most of our exports are either destined for the US or are denominated in dollars. Contrarily, the rising rupee makes it attractive for us to buy foreign goods in place of local products. Both ways, it is counter-productive for the economy. So, the RBI tries, or should try, to keep the value of the rupee from rising too high by buying up the dollar inflows. This explains the continuous increase in reserves, now at more than $100 billion.
The RBI apparently decided on a change of stance sometime last month. It stayed off the forex market and allowed the rupee to rise. Today, the rupee stands nearer Rs 43.3 to the dollar than the Rs 49-and-odd we had seen earlier. There are winners and losers. Those who exported based on a cheaper rupee are now forced to cut their dollar prices. This hurts exporters, particularly of manufacturers who depend very little on imports but more on labour. Skilled labour, which dominates our software industry, is one of the likely sufferers. The rising rupee has unwittingly struck a blow in favour of the American argument against outsourcing. It imperils our comparative advantage at its roots.
True, defenders of a rising rupee argue that it has had little impact on our exports. Facts and figures are thrown in our face to show that exports grew by nearly 17 to 18 per cent in the last year in spite of the rising rupee. Further, it is argued that exporters are already favoured too much by way of tax concessions and special treatment. They should improve their efficiency and productivity. Japan’s exports did not go down in spite of the rising yen. And so on and so on.
A further argument against RBI intervention to keep the rupee down is that such intervention will be inflationary. For one thing, the buying of dollars by the RBI will increase the supply of rupees. That is, unless that amount of rupees is sterilized by the RBI’s selling government bonds in exchange for rupees. Experts point out that the RBI is already short of government bonds. It has recently resorted to special devices, such as stabilization bonds issued by the government of India, which it can sell to suck up and sterilize the rupees. In essence, these bonds are rupee-denominated government debt paper. While the RBI is not completely out of the market, it is at the end of its tether.
Does this mean that the rupee is “fated” to go higher and higher' I believe the RBI has to resort to continued intervention to keep the rupee from climbing further. After all, we are in competition not only with the US, but also with China which is keeping its currency steady against the dollar. Japan, in spite of nearly a trillion dollars in reserves, is keeping the yen from rising by buying up the dollar inflows. So is China, in spite of its treasure trove of nearly $435 billion. Countries like China and India cannot afford to let their currencies appreciate with the inevitable impact on local industrial competitiveness. It is not for nothing that Japan adopted a cheap yen policy at the beginning of its development. It was on the basis of its 360 yen to a dollar that Japan scripted its growth to economic dominance.
It is a pity that visions of a strong rupee are apparently influencing our policy-makers. True, the rupee can be strong when we overcome our systemic deficiencies and low productivity to match the developed world. It is no use pointing to Singapore’s indifference to its appreciating currency as a solution to our problems. China is resisting all blandishments by the US to revalue its currency. India should also not unwittingly lend its ear to the expostulations of the US to make the currency of developing countries dearer in relation to the dollar.
What caused the RBI’s change of stance' Many theories are afloat, although I believe that the RBI has not been guided by any extraordinary impulse to refrain from intervention. Its stance in favour of non-intervention may perhaps have been influenced by the inflationary impact of a cheaper rupee, which translates into higher domestic prices for petrol, crude and so on. Perhaps, it was in order to bring inflation under control that the RBI refrained from letting the rupee drop. But, the rising rupee could contribute to a serious loss of jobs. Particularly, our nascent software and outsourcing industry can be badly hit by a rising rupee. This will be a “cure” worse than the disease. The effect will be to choke the inflow of dollars from these industries. It will also mean a permanent loss of jobs.
The capital inflows that have led to the recent embarrassment of riches remind me of a disease which afflicted the Netherlands in the Seventies. The discovery of large gas reserves led to a huge inflow of dollars into the country, with familiar repercussions. The Dutch industry lost its competitive edge. Jobs were lost and the strong guilds became a prelude to a weak economy.
Hopefully, we will not fall prey to the same disease. The rupee has to remain at such a level as to make the country’s exports competitive. The RBI has to use its ingenuity to devise policies to use the forex hoard fruitfully and, at the same time, continue to intervene in the market to keep the rupee steady. True, it has problems deploying its reserves. Today, it lends them at low rates to the US. It incurs a quasi-fiscal loss on this account. Maybe it can deploy its dollars better by lending them to Indian commercial banks with a proven record so that they can enable corporate bodies to increase investment in capital equipment. After all, today corporate bodies make commercial borrowings from foreign banks. The RBI lending to corporate organizations through Indian banks will be definitely more profitable and less risky than its lending to a deficit-ridden US economy.
Ultimately, wisdom lies in framing a currency policy that keeps long-term economic objectives in view. This cannot be attained by keeping the rupee strong, which ends up increasing imports and decreasing our export competitiveness. Hopefully, the RBI will reveal its mind when it comes up with its next credit policy soon. But by then the markets will have lost a great deal of confidence in India’s continuing competitiveness. We should not be listening to the voices of the US and Brettonwoods to revalue our rupee. It is our jobs that are at stake. A strong rupee weakens our economy more than appears on the surface. Let us not lose our strength pursuing the mirage of a stronger rupee, however tempting the goal may appear for advocates of tokenisms like “Shining India”.