September 11, 2008

Manish Marwah - Advisor and Management Consultant


Appreciation of Rupee - A Boon or Bane

Millon dollar question- one of the most popular saying, might change in future to million rupees question if this present era of rupee appreciation continued to be on roll.

Indian economy is among the fastest growing economies of the world. The appreciation of rupee against dollar will prove out to be another huge addition to its economic prosperity and growth story. However the economic epidemics like poverty, unemployment etc cannot be dealt in short run.
From 2003-08 Indian market is booming in leaps and bounds, today after china India is 2nd fastest growing economy of the world with registering a growth rate of 9%. India is a trillion dollar economy and has become world’s 12th largest economy (2008 estimate). Now major question drifting in every Indian mind is “Rupee Appreciation”. The rupee appreciated by 9.8% against the US dollar during the previous financial year between April 3 , 2007 to January 16 2008.

The rupee appreciation against US dollar over the past 12 months on year to year basis (December 2006 – December 2007) was a higher 13.2 %. The appreciation of rupee against other major currencies was much less than against the US dollar.
India witnessed 2nd highest appreciation in its currency of 8.35% between January and June 2007 after 9.28 % of Brazil among the emerging economies that are in direct competition with Indian exporters and find themselves better off due to sharp rise in rupee value, revealed by ASSOCHAM eco pulse study.
After having looked at these figures, the puzzle that floats in our mind, will the appreciation of rupee adversely affect our economic growth or it is an indicator of Indian growing economy?

What Lies Behind This Appreciation

The major reason which draws attention towards this rupee appreciation has been a flood of foreign-exchange inflows, especially US dollars. The surge of capital inflows into India has taken variety of forms ranging from foreign direct investment (FDI) to remittances sent back home by Indian expatriates. The main impact of these flows is as follows:

FDI: India’s starring economic growth has created a large domestic market that offers promising opportunities for foreign companies. Moreover many companies rising competitiveness in many sectors has made it an attractive export base.

ECB (external commercial borrowings): Indian companies have borrowed enormous amounts of money overseas to finance investments and acquisitions at home and abroad. This borrowed money has returned to India, boosting capital inflows. In 2007-08 (april-september) external assistance (net) was placed at US $ 729 million as against US $ 386 million for the corresponding period in 2006-07 indicating a growth of 88.9%.

Foreign portfolio inflows (FII’s): India’s booming stock market embodies the confidence of the investors in the country’s corporate sector. Foreign portfolio inflows have played a key role in fuming this boom. Looking at the period of 2003-04 and 2006-07, the net annual inflow of funds by foreign institutional investors averaged US $ 8.1bn. Trends during first five months of 2007 indicate that this flood is continuing with net FII inflows amounting to US $4.6 bn. Another major source of portfolio capital inflows has been overseas equity issues of Indian companies via global depository receipts (GDR’s) & American depository receipts (ADR’s). Moreover FII’s registered in India has doubled to 1050 between March 2001 –march 2007 and now around 3,336 FII subaccounts also exist. FII equity flow has increased from $9.8 billion in 2004, $ 11 billion in 2005 to over 16 billion in 2007. The stock market has buoyed by strong corporate performance and these inflows have risen to 43% in 2007. However in mid-October RBI banned foreign investment via off shore derivatives called participatory notes (PN). These derivatives were used by foreign investors not registered in India (say hedge funds) to indirectly invest through registered investors. Between Mar 2004 – Aug 2007 the number of FII sub accounts that issued PNs rose from 14 to 34. Many believed that motive behind such RBI measure was to improve transparency of capital inflows and that restricting inflows via PN would have little or no impact on overall inflows coming into the country.

Investment and remittances: Another major source of capital inflows has been non-resident Indians (NRI’s) investing large amounts in special bank accounts. While NRI’s emotional connection to the country of origin is part of explanation to this, the attractive interest rate offered on such deposits also provide a powerful incentive. In 2006-07 NRI deposits amounted to US$ 3.8 bn. another large source of foreign exchange inflows has been remittances from huge number of Indians working overseas temporarily. Such remittances amounted to a colossal of US $ 19.6 bn in April-December 2006, a 15% year on year increase.

Impact on Importers - The Gainers According to an industry analyst: every 10 paisa appreciation in rupee negates one dollar upward movement in international price.
Rupee appreciation brings jovial time for importers. Major imports to India are petroleum products, capital goods, chemical, dyes, plastics, pharmaceuticals, iron and steel, uncut precious stone, fertilizers pulp, paper etc. during the periods when dollar was getting strong against rupee, when 1$ = Rs 48 importers used to pay Rs 4800 for every $100. Since the beginning of the year 2007, rupee has appreciated nearly to about 10%. With value of rupee Rs 39.35 = 1$ for every $100 importer has to pay Rs 3935 by gaining a profit of Rs 865. This gain will bring about savings in cost which can be passed on to consumers, thereby becoming immediate tool for controlling inflation.
Over 10% appreciations in domestic currencies against dollar has thrown a new M&A opportunity for India Inc which wants to reach out world by acquiring going concern on a global scale. An ASSOCHAM study of 70 deals done in the first six months of the last financial year( 2007-08) , in which Indian firms undertook buyouts worth $ 14 billion , has revealed that Indian companies would have saved Rs 6500 crore ($ 1.66 bn) just because of increase in rupee value.
Due to continuous decrease in dollar value, the US had remained the most favorite hunting ground for Indian companies. $2.9 bn valuation deals were announced with US companies in financial year 2007-08.
In terms of sector analysis steel rule the rest owing to the Tata-Corus deal. The overall valuation of M&A in steel sector was of around $5.4 bn.

Rupee appreciation is also welcomed by companies which have overseas borrowings. Significant levels of foreign currency –denominated, especially US denominated loans generate forex gains because of reduce interest payments which are occasioned by rising Indian rupee. Companies like Ranbaxy and L&T have been able to generate forex gains because they have substantial exposure to ECB’s.

Impact on Exporters -The Sufferers

With the ratio of 70:30 of imports and exports the major export destinations of India are USA, EU, Japan, Brazil and other Asian countries. Products which generate revenues from these destinations mainly compose of handicrafts, gems, jewellery, textiles, and ready made garments, chemicals and other related products. As seen for imports, if we analyze if an exporter is getting Rs 3935 now instead of Rs 4800 he is at a loss of Rs 865. This loss will lead to erosion of exporter’s profit margin and will affect their competiveness in global market.

In contradictions to the apprehensions of that there would be shrink in profit margins of exporters due to emergence of strong rupee, the latest studies of ASSOCHAM exhibit that stronger rupee will bring in rich dividends for India Inc and boost its profit margins between 12-15% in long run as exporters are brininging new technologies with cheaper imports for expanding their existing capacities.

The chamber holds that a strong rupee would reduce the cost of imports and would have some positive impact on those exporters which have large import content as witnessed from figures above. It further recommended that if companies are able to expand their capacities in rupee appreciating scenario, they would in the long run , definitely be in win-win situation as demand for Indian exports in developed countries would not slow down. The India Inc would be able to export at very competitive prices as a result of capacity building through technological advancements and increase in margins by 12-15%.
Policy Dilema
Indian policymakers are struck with difficult crisis. On one hand, the stronger rupee has benefited the economy by making imports cheaper. On the other hand due to both economic and political reasons policymakers cannot afford to ignore the problem of exporters. India‘s rapid export growth in recent years have been the major accelerator of economic growth.

If RBI intervenes to stop rupee from appreciation further , it may turned out to be a boon for export oriented units and crate more employment but at the same time this may also bring in inflationary tendency to the market. Therefore government is in dilemma of choosing between inflation and unemployment.
There is a limited extent to which RBI can intervene in the foreign exchange market in the face of large sustained capital inflows; policymakers can stem rupee appreciation substantially by easing limits on domestic firm’s overseas investments or restricting inflows – for instance, through further control on ECB’s. The RBI has already taken tentative steps in this direction making it more difficult for Indian firms to borrow in foreign currency and eliminating the exemption from ECB limits which used be previously enjoyed by real estate firms. ....