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Business Commentary/Dilip Thakore

A convertible rupee would have dropped like a stone

The continuous slide in the value of the rupee against the major western currencies and the all-conquering American dollar in particular, seems to have dividend Indian industry and academia into two opposing camps.

In the blue corner are the nation's exporters who welcome the sharp fall in the value of the rupee from Rs 37.88 to the dollar three weeks ago (November 17) to Rs 39.24 currently (December 18), after hitting a new low of Rs 39.80, as an overdue market correction to an overvalued rupee. In the red corner is a smaller crowd of more cautious academicians, jingoists and others who are worried about the impact of a sharply depreciated rupee on the nation's import bill. And at the time of writing, the blue corner seems to be winning. At a time in the nation's history when almost all the erstwhile supporters of the command economy seem to have suddenly metamorphosed into champions of free markets, there is of course a strong argument for allowing 'market forces' to determine the value of the rupee.

The currency turmoil in the export-oriented economies of Southeast Asia has resulted in their currencies being devalued by 15-50 per cent, the impact of which has not been adequately highlighted by this nation's West-fixated media. There's no doubt that exporters in these nations have involuntarily acquired an additional price advantage over their counterparts in India where the value of the rupee has been stabilised by the market intervention of the Reserve Bank of India. Therefore, a corrective fall in the value of the rupee is in the national interest.

But the big question is whether in deference to the new mantra of liberalisation and deregulation, the rupee should be allowed to find its own level as determined by mysterious market forces. If in deference to this new flavour of the season, the rupee is permitted to go into free fall without RBI market intervention, there is a clear and present danger that it might disappear altogether from the radar screens of the world’s current traders. For the simple reason that thanks to the ridiculous centrally planned import substitution policies pusued by this nation for the past four decades, India, with barely one per cent of world trade, is not anywhere near to being numbered among the world’s major trading nations. Therefore, the demand for the rupee is inherently weak.

And while there is some merit in the argument of Indian exporters that the value of the rupee needs to be realigned so as not to be completely out of sync with the Thai, South Korean, Malaysian and other Southeast Asian currencies, this argument is of limited validity. For one, because exports contribute hardly 10 per cent of the nation’s GDP. And secondly, because price competitiveness is only one of the factors which make for successful penetration of markets overseas. Product innovation, quality and timely delivery are perhaps – as Japanese industry has convincingly demonstrated despite the continuously rising value of the yen – more important considerations. And unfortunately India’s exporter’s community has a long way to go before they can offer these product and service attributes to win significant market shares abroad.

Indeed, far from being an export-oriented economy which would benefit from a sharp devaluation (which would make Indian goods and services cheaper in foreign markets) of the rupee, the harsh truth is that despite four decades of import-substitution oriented central planning, the Indian economy remains heavily imports-dependent. And a sharp fall in the value of the rupee will jack-up the prices of imports and uncork the dreaded inflation genie. The argument advanced by free-fallers is that international crude oil prices are soft and therefore, petro products import bill is not likely to rise significantly. But this argument overlooks the reality that petro products apart, the nation imports non-petro goods valued at over Rs 1000 billion annually. And the prices of these imports are certain to rise to the extent the rupee depreciates.

Therefore, quite obviously, continues monitoring and periodic intervention by the RBI to maintain the value of the rupee within a near 10 per cent band of the real effective exchange rate, which is based on trade fundamentals including the depreciation of competitive currencies, is necessary and justified. Currently, the REER is hovering around Rs 38.50 to the dollar. Given the imports-dependency and exports-inelasticity of the Indian economy, permitting market forces (which in reality means anonymous bureaucrats in the economic ministries since the RBI is the major buyer and seller of foreign currencies) to arbitrarily determine the value of the rupee is an option pregnant with disastrous consequences.

The ground zero level reality is that the Indian economy characterised by a collapsing infrastructure, dominant non-performing public sector, a skills-deficient banking sector stuck with huge bad debts, and chronic political instability cannot support a strong rupee. If the rupee hasn’t depreciated to the extent of the won, baht and the ringgit, this is not the consequence of the inherent strength of economy or astute economic management. The prime factor behind the relative stability of the rupee is the lack of national self-confidence resulting in procrastination on the issue of the full convertibility. If the rupee had been convertible on the capital account as the currencies of the beleaguered Southeast Asian nations are, there would have been a massive flight of capital which would have been seen the value of the rupee drop like a stone into a deep abyss.

The immediate priority of the Indian economy is a massive restructuring and privatisation initiative which will provide a solid foundation for consistent near double-digit annual economic growth. Until this initiative is taken and is well under way, permitting the market to determine the value of the rupee would be tantamount to downright fiscal and economic irresponsibility.

Dilip Thakore