Protect the rupee, kill the economy

Also, the very large natureof short-term debt of some of these countries will force them to continue to export at all costs for several years to come — the debt, after all, has to be repaid. South Korea’s short-term debt of $24 billion, for example, has to be repaid in three years. In other words, India’s exports will continue to be at a big disadvantage vis-a-vis those from south-east Asia for some years to come. The issue then is of the kind of costs the policy of protecting the rupee is imposing on the country, and whether these are worth paying.

In the textiles sector, for example, the crash of the Indonesian rupiah has resulted in a situation where prices of cotton yarn have fallen from around $3.9 per kilogram three months ago to around $2.9 today. Price cuts for polyester-cotton and viscose-cotton blends have been even more severe and are in the region of 50 per cent. Coupled with the high price of Indian cotton, thanks to a poor local crop this year, it is estimated that close to a sixth of the country’s operating textilelooms in centres such as Panipat are operating at just around 20 to 30 per cent capacity.

At these prices, experts believe that, far from growing, India’s $10 billion exports of cotton, yarn and textiles may even decline in the current year. With exports forming a vital part of the country’s production, this means that large sections of the textiles industry can be expected to go under soon.

A similar story is repeated in other areas such as petrochemicals and steel. With prices of several key petrochemicals falling by as much as a third, several players have cut production levels. A fifteen per cent fall in prices of steel imports from South Korea in the last four months has resulted in imports rising sharply — as against imports of 35,000 tonnes of hot rolled coils from South Korea in 1996-97, the country will import over one lakh tonnes this year. Three points are generally raised by proponents of a strong rupee to counter these sort of arguments. First, exports are usually a function of overallcompetitiveness, not just prices — in which case, allowing the rupee to fall, just to compete with other countries’ devaluations, will not help increase exports.

Second, even if the country loses out in terms of some exports not taking place, it gains from not allowing its foreign debt to increase in terms of its local currency. Every fall of one rupee in the exchange rate, for instance, inflates the country’s national debt by around Rs 9,000 crore.

Third, if the rupee is allowed to fall beyond a point, imports get prohibitively expensive and given that most of India’s imports consist of essentials like crude, this will raise overall inflation levels. The problem with this sort of argument, however, is that it ignores certain ground realities. For one, with prices of several critical imports such as crude and petrochemicals at an all-time low, the landed prices of imports won’t go up by as much as is feared. Second as long as dollar inflows keep taking place, whether through foreign direct or portfolioinvestment, to replace the debt redemptions of around $16 billion over the next 24 months, it doesn’t really matter what the exchange rate is.

But does the rupee-dollar rate affect foreign investment and inflows? Will more foreign investment come in if the rupee is allowed to touch 42 to the dollar? While there is clearly no fixed rule to this, a few points can be made. It is true that foreign investment inflows — both direct as well as the portfolio type — are influenced more by the policy environment within the country than by the exchange rate.

That, however, is missing the point. If local industry continues to do badly, either due to substantially cheaper imports, or through substantially lower-price competition abroad, this will ensure that economic growth remains poor. This will slow down overall inflows, at least in the form of portfolio investments — this is precisely what has been happening in the country for most of the last few months. If this continues, Dr Jalan would be hard put to balancethe outflows and the inflows of foreign exchange –that, ironically, is the main reason given for preventing the rupee from depreciating fully!