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Strong rupee, stronger growth

G. Ramachandran

The orthodox view has been that India could do better as an exporting nation than its Asian rivals by allowing its currency to decline. But, unlike Asia's tigers, the Indian economy depends on domestic consumption to sustain equitable and widespread growth. The impact of the rising rupee on the affordability of basic goods would be significant, especially by those at the bottom of the purchasing power pyramid. By so doing, it would make growth more equitable, says G. Ramachandran.

INDIA'S economic growth objectives will be better served by a strong rupee vis--vis the US dollar. The equitability, consistency and speed of growth will be favourably affected by the `strong rupee' policy. In the main, it is pro-poor, pro-employment and pro-growth. It is not surprising that the incumbent government has recognised the merits of the strong rupee.

The strong-rupee policy is inclusive and expansive. It will spread the benefits of growth across nearly 200 million households, and especially across the 74 million households at the bottom of the purchasing power pyramid. The consumption of basic goods will rise as a result of the strong-rupee policy. Basic goods constitute a significant part of the consumption basket of poor households and generate almost 94 per cent of the employment in poor households.

The estimated positive impact rises with the strengthening of the rupee. At Rs 43 to the US dollar, the nominal annual growth in purchasing power deployed on basic goods would be about 14 per cent. The aggregate annual growth in purchasing power would be about 20 per cent. At Rs 40 to the dollar, the growth in basic goods would be about 18 per cent. The aggregate growth would be about 22 per cent.

The discourse on the merits and demerits of the strong rupee has been informed and driven by India's export competitiveness. Detractors of the strong-rupee policy could argue that some export competitiveness would be lost in a mercantilist world where India's rivals could increase their market share by keeping their currencies undervalued.

The dollar closed at Rs 43.68 on March 31, 2004. Ardent advocates of the weak rupee may yearn for the dollar to rise to Rs 48.96, its value on April 3, 2002. But they may have to be reminded that its value was Rs 43.68 in May 2000.

So, the rupee is merely regaining its lost strength after four years on the back of significant gains in capital and human resource productivity.

Global firms expect further gains in productivity. Hence, those that are dependent on the weak rupee for their competitiveness should re-engineer their export businesses soon.

Discarding a stereotype

Asia's tiger economies typically grow when their exports of manufactured goods grow. They depend on exports to sustain employment, incomes and aggregate internal growth. A very significant part of their workforces that earn medium and high incomes is deployed on tasks related to exports. Domestic employment, incomes and consumption would decline significantly without external consumption.

External consumption `leads' their economies. Domestic consumption `follows'. Therefore, Asia's tiger economies have an incentive to promote external consumption.

The undervaluation of their currencies is one of the principal means to promote exports and, thereby, their internal economies. If tourism is regarded as an export-earner, which it is, the picture of export-led growth is complete. It is good to root for and cheer currency undervaluation! But the stereotypical argument in favour of a weak rupee has to be discarded for one important reason.

Unlike Asia's tiger economies, the Indian economy depends on domestic consumption to sustain equitable and widespread growth.

Discarding an orthodoxy

The all-round positive impact of currency undervaluation by many Asian economies on their employment, incomes and aggregate growth has made a somewhat deep impression in India. In a mercantilist world where one country could exploit other countries by undervaluing its currency, a weak rupee has been regarded for long as the right recipe for India's competitiveness and economic growth. The orthodox economic view has been that India could do better as an exporting nation than its Asian rivals by allowing its currency to decline even while strictly adhering to the principles of free markets and fair evaluation. A corollary of this orthodox view is that the rupee could appreciate only through intervention by the Reserve Bank of India in the currency markets and through higher short-term interest rates.

The orthodoxes regard the strong rupee as an irksome aberration that results from intervention and as a hurdle that exporters should cross. Any suggestion that India could do well with a strong rupee has usually been welcomed with derision.

Heretics alone could suggest that a strong rupee could be valuable to the economy. Those that had a grand view that exports would push India to the forefront of the briskly growing economies and that a weak rupee would make exports competitive formed the orthodoxy that the rupee ought to depreciate.

The dismal share of India in world trade and an even more dismal share in the imports by the European Union, North America, Japan and Australia from India have not tempered the orthodox view. But the heretics are winning now.

Embracing the heretics

The Indian matrix of inputs, output, incomes, purchasing power, consumption and economic growth does not fit the typical export-led model of growth. It fits the strong domestic-consumption model. Domestic consumption drives aggregate purchasing power.

An analysis of the purchasing power and index of economic activity included in India 500 Plus, a database published by the Business Intelligence Unit, shows that domestic economic activities comprehensively explain aggregate consumption.

The activities include agriculture, manufacturing, transportation, construction, housing, trade, professional services and financial services. Most of these activities are material-intensive. They require fertilisers, steel, non-ferrous metals, petroleum products, cement, timber and heavy chemicals. India is a significant importer of these. Without imports, the principal drivers of the domestic economy would lose steam.

But domestic economic activity, incomes and consumption are inversely related to the costs of inputs such as steel, coking coal and crude oil. Rising prices of fertilisers, steel, non-ferrous metals, crude oil and petroleum products, cement and heavy chemicals suppress domestic economic activity, incomes and consumption.

The converse is that falling prices will boost the domestic economy and stable prices of critical inputs will lead to steady growth. The relationship is so strong that the Government has postponed the increase in prices of petroleum products and placed controls on steel mills with the objective of keeping steel affordable.

Affording equitable growth

The rise in the value of the rupee would mitigate or, perhaps, nullify the rise in commodity prices invoiced in dollars. Commodity prices are back to their 1995 levels. The broad dollar index of commodity prices has risen by 33 per cent since March 2003.

Crude oil, a major Indian import, has risen by 34 per cent. Food prices have risen 32 per cent. Prices of non-food agricultural produce, say, cotton and timber, have risen 22 per cent. Above all, prices of metals, minerals and coking coal have shot up by almost 50 per cent.

By contrast, the broad euro index of commodity prices has risen by 15 per cent. The broad yen index of commodity prices has risen by 18 per cent. Euro area economies, Japan and Australia (the Australian dollar has risen from 1.67 to 1.34 to the dollar since March 2003) have used the strength of their currencies to soften the impact of rising commodity prices. The rupee may not appreciate to its 1995 value against the dollar but such an appreciation would push domestic consumption. The strong rupee would make growth both affordable and equitable. The impact of the rising rupee on the affordability of basic goods and simple-branded goods would be significant.

It would expand the availability of critical inputs at prices that can sustain production and consumption by ordinary households, especially by those at the bottom of the purchasing power pyramid. By so doing, it would make growth more equitable. Some luxury goods may become less affordable to those who depend on the weak rupee for export competitiveness.

But domestic consumption of basic goods and simple-branded goods will steam ahead on the back of the strong rupee. Basic goods and simple-branded goods are powerful creators of all-round employment. This will bring cheer to millions of households at the bottom of the purchasing power pyramid. Let's cheer the strong rupee.

(The author is a financial analyst. Feedback may be sent to indiagrow@sify.com)

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