The Undervalued Rupee
It’s the perennial question: is the Indian rupee undervalued or overvalued – or indeed, is it currently at its correct value? There’s a strong lobby in India that believes in a weak rupee. Led by exporters, this lobby has over the years successfully created an ecosystem among economists, analysts and the bureaucracy which propagates the belief that a constantly depreciating rupee is good for the Indian economy. So powerful is the impact of this decades-long lobbying that it is now accepted wisdom that a weak rupee is a good rupee.
Are the votaries of a weak rupee right? The answer: no A constantly depreciating rupee is a Sword of Damocles over the heads of importers. With crude oil prices rising to over $100 a barrel, India’s trade deficit in 2021-22 is likely to hit record highs.
Weak rupee advocates ignore several facts. First, the most successful export leviathan in history, China, with exports of over $3 trillion a year (equal to India’s entire GDP) has never suffered due to a strong yuan. The Chinese currency has been trading at a steady exchange rate of 6-8 yuan per US dollar between 2006 and 2022.
In 2006, the yuan was trading at 7.97 per dollar. In 2022, it is trading at 6.35 per dollar. Thus in 16 years, the yuan has actually strengthened by around 20 per cent against the US dollar.
Have China’s exports been adversely affected as a consequence? In 2006, Chinese merchandise exports totalled $1.43 trillion. In 2022, Chinese exports are expected to be well over $3 trillion. The increase in Chinese exports by over 100 per cent, despite the strengthening of the yuan against the dollar by 20 per cent during the same 16-year period, speaks for itself. The clear inference is that other factors affect exports more than just a weak currency. The first among these is quality. The second is timely shipping. The third is a diverse range of exportable merchandise. The fourth, finally, is scale.
Scale and range need large investments. Timely shipping requires impeccable logistics, quick local transport, low taxes and flexible labour. Quality obviously needs skilled manpower.
The Narendra Modi government is aware of the importance of these four factors. It has laid great emphasis on upskilling to improve the quality of Indian products across the supply chain. It appointed AM Naik, Group Chairman of Larsen & Toubro, as Chairman of the National Skill Development Corporation (NSDC).
Meanwhile Road Transport and Highways Minister Nitin Gadkari has focused on improving logistics with new highways criss-crossing the country to speed up delivery of merchandise to ports while saving on fuel costs. Railway Minister Ashwini Vaishnaw is enhancing faster dispatch of freight to ports for export.
Finally, scale and range of merchandise. This needs private industry to step up. The Production Linked Incentive (PLI) scheme is proving to be a winner. India is set to become an export hub for passenger cars, mobile phones, electronics equipment and over a dozen other manufacturing sectors. This will provide India’s export basket with both range and scale.
In 2021-22 Indian exports are likely to cross $400 billion for the first time. The rupee has been steady at around 75 to the US dollar for the past two years. In pre-pandemic 2019-20 too, the exchange rate was stable. Yet exports have risen from $314.31 billion in 2019-20 to an estimated $405 billion in 2021-22.
At $405 billion, exports will still comprise only 13 per cent of India’s GDP ($3.1 trillion). For China that figure is over 20 per cent ($3 trillion exports on a GDP of around $15 trillion). India’s high import bill (due mainly to crude oil and gold imports) has caused an unsustainable trade deficit. Were it not for booming services exports (largely software), foreign direct investment (FDI), foreign institutional investment (FII) and NRI remittances, India’s balance of payments (BoP) would have plunged into negative territory.
Historically, the Indian rupee was pegged at 3.30 to the US dollar in 1947. It remained relatively stable for the next 40 years. In 1990 it traded at 17.01 to the dollar. The slide started in 1992. By 1995, the rupee had plunged to 32 to the dollar and by 2014 to 60. In the past eight years, the slide has slowed but not stopped. The contrast with the yuan is striking.
A stronger rupee would dramatically cut India’s merchandise trade deficit. Would software exports be affected? Not if they climb up the value chain. And indeed they are doing precisely that. The digitalisation of global enterprises has given the big four IT services companies – TCS, Infosys, Wipro and HCL Technologies – an opportunity similar to Y2K in 1999. The transformation to digital and a slew of innovations in artificial intelligence, deep machine learning and SaaS (Software as a Service) will give Indian IT companies new business opportunities well through this decade.
Commerce and Industry Minister Piyush Goyal declared recently at a FICCI event: “Aspiring for $1 trillion exports of services and merchandise each by 2030 is possible. India in 2024 should be a transformative change from our current thinking. We must set aggressive and accelerated goals and business and industry will also have to look at extremely large targets into the future. The world is looking at us and the country needs to start looking at big picture ideas and opportunities. We are looking at getting more opportunities for Indian businesses and I have no doubt that this will give us a huge leg up in international trade. For economies of scale, we will be able to bring down costs and improve the quality of our products.”
The Indian-UAE Comprehensive Economic Partnership Agreement (CEPA) is a precursor to similar Free Trade Agreements (FTAs) with Britain, Australia, the European Union and the GCC. This would help boost exports further. As Goyal said after the CEPA deal with the UAE was inked: “The CEPA will create jobs for our youth, open new markets for our startups, make our businesses more competitive and boost our economy."
All of this will moderate pressure on the rupee even as the US Federal Reserve begins its taper programme. It is clearly an appropriate time to rethink India’s traditional weak-rupee policy.
