The Hindu Business Line : Dearer rupee, cheaper India!

Some say that the appreciating rupee could enable commodities, especially petro-products, to be priced lower. But there are problems with this argument.

Mr S. Gurumurthi, activist and columnist, has started an important debate in a national newspaper suggesting that an appreciating rupee can be better for India, as it can enable commodities, such as petrol, to be priced lower than they are now.

Indeed, he suggests that petrol can sell at Rs 30 per litre if the rupee/dollar ratio is Rs 9, instead of Rs 45 to the dollar it is now. In a hard-hitting series of articles, Mr Gurumurthi has called for a national debate on this issue.

The debate on exchange rate of the rupee is as old as the rupee itself. In an interesting aside on the subject in Oscar Wilde's play, Importance of Being Ernest, a character advises the principal heroine to lay aside the chapter on the rupee as it might be too disturbing.

The fact that the value of the rupee was of interest to Englishmen and women in the 19th century is evidence of the tremendous impact it had on the returns the English people derived from investments in India, which were denominated in rupees and whose returns had to be exchanged into sterling.

At the time of Independence, we had substantial sterling balances. When the UK devalued the sterling as a result of its high debt burden following the Second World War, much of our balances also disappeared as there was no protection of value. We were linked to the sterling than, even as we are today linked to the dollar, in a manner of speaking. We face a similar risk in the form of erosion of our dollar balance if the dollar devalues — a catastrophe waiting to happen!

Undervalued rupee

The question Mr Gurumurthi raises is whether we are making a mistake in keeping the rupee undervalued. He concedes that this has certain advantages in terms of export competitiveness. But he argues that in keeping the rupee undervalued, the Reserve Bank of India accumulates a lot of reserves by buying up forex from exporters and their forex carriers; these reserves are invested in low- interest-yielding US securities — an unprofitable transaction.

Mr Gurumurthi is aware, as much as any other expert, that the insistence on high reserves is a consequence of the fear of erosion of reserves, which can happen in a developing economy. Particularly, memories of the East Asian financial crisis influence policy-makers' preference for a comfortable level of reserves.

So, far from the devaluation of the rupee being a cause of the high reserves, high reserves are a result of a conscious policy decision to hold a safety stock to guard against a repeat of the East Asian crisis in the Indian context. True, opinions can differ on how high the reserves should be to protect the economy against attacks by speculators. But the RBI has explained clearly that the current level of reserves offers a sufficient degree of protection and confidence to investors abroad.

Higher purchasing power

Mr Gurumurthi's arguments are more sophisticated than those summarised above. They rest on the simple proposition that the true purchasing power of the rupee is higher than what is represented by the Rs 45 to a dollar level. Granted that there is a discrepancy between its actual purchasing power and what is represented by the exchange rate, which is determined by demand and supply of external currency in the market.

Different exercises have been undertaken by experts to evaluate the real purchasing power of a currency. But they almost always fall short of an ideal measure because the consumers' baskets of goods and services are difficult to determine. Again, services are not tradable in the pure sense of the term. A hair-dresser's service, for instance, may be cheaper in India than in the US, but it is difficult to conceive of its export, even in these days of digital revolution. The question of how far a dearer rupee will solve the problems of India's highest economy has to be examined, keeping in view its present high trade and current account deficits. India imports far more goods and services than it exports. The need of the hour is, therefore, to increase the competitiveness of our exports and decrease the price attractiveness of imports.

For this, there is no solution other than to make exports cheaper to the buyer abroad and imports costlier to the Indian consumer so that market forces can help demand and supply to balance. Given our WTO commitments, which Mr Gurumurthi recognises, there is a limited, or no scope, for improving tariffs on imports and giving subsidies to exports. Ipso facto, the gap in current account is in danger of increasing if the rupee becomes dearer.

While the dearer rupee may lead to cheaper petro-products, we may not then have the forex through exports of goods and services to import the crude and petro-products we need.

Export competitiveness

Exchange rate policies are not written in stone and there is something to be said for a flexible approach, keeping in view the impact on cost of living. But the principal factor is the current account deficit, which demands export competitiveness, and that is an argument for a cheaper rupee.

Consider, especially, that our competitors, principally China and South-East Asia, are managing their currencies to be effectively devalued, notwithstanding the US pressure on China in the reverse direction. Mr Gurumurthi concedes that China has an opposite lesson to offer. But he seems to draw the conclusion that China is less dependent on crude imports than India is. China, he says, imports less than one-third of its crude requirements and India more than two-thirds of its requirements. So, he argues, India's risk of the general domestic economy turning uncompetitive because of high fuel costs is twice as high as China's if the rupee is undervalued.

I would like to suggest that Mr Gurumurthi's argument based on the ratio of dependence of China's crude imports is misplaced. What matters is that China has an export surplus on both its goods and services, which enables it to finance its crude imports, whatever its relative size. On the contrary, India is dependent on capital flows to support imports of commodities because it has a deficit on current account. Clearly, there is need for India to pursue its export competitiveness — if need be, by devaluing the rupee rather than revaluing it.

One answer to the problems posed by Mr Gurumurthi in one of his articles — costly petro-products — may be the adjustment of taxes on these products. But that is difficult, given the fiscal problem faced by the Centre and the States. It is also easy to see that conservation of energy is helped only by policies which translate high crude prices in the global markets to equivalent market prices. Subsidies, either in the form of low Customs or excise duties, will only induce heavier consumption of imported petro-products.

Practical policy considerations are against Mr Gurumurthi's suggested solution. Japan rose to its heights on the strength of a weak yen rather than a strong currency. Can India too be strong on the back of a weaker, rather than a stronger, rupee?