Strong Rupee VS Weak Rupee
The basic advantage of devaluation is that it makes exports cheaper and makes imports costly. All through the last 66 years of independence, India has exported less than it has imported in dollar terms. India's exports during 2012-13 stood at about US $300 billions, while imports aggregated at about US $492 billion. Trade deficit thus stood at $191.6 billion.
If the conversion rate was Rs 40 to the US$, the trade deficit in Rupee terms would be Rs 7664 billions. If the conversion rate was Rs 60 to the dollar, the trade deficit in Rupee terms would be Rs. 11496 billions. In other words, Indian people are paying extra Rs 3832 billion or Rs 3,83,200 Crores for the same levels of imports just because of the governments failure to check the slide in the Rupee.
If there was 10% devaluation in the Indian Rupee and the imports and exports remained the same in volume, the dollar cost of imports would go up to about US$ 540 billion and receipts from exports will reduce to US$ 270 billion. The current account deficit would increase to US$ 270 billion. On the other hand if the Indian Rupee appreciated by 10% and volumes remained the same, the cost of imports would be US$ 452 and the cost of exports would rise to US $ 330 billion and the trade deficit of US$ 270 billion would be reduced to US$ 122 billions.
Even if the volume of exports dropped by 10% due to the appreciation of the rupee by 10%, the revenue from exports would be US$ 270 billion and trade deficit will drop from US$ 270 billion to US$ 180 billion. It will be obvious to the dumbest, that a strong currency will always be advantageous to those countries which have a perpetual trade deficit.
The United States understands this fact much better than most other countries. That is why it spares no effort to maintain a strong dollar. Unfortunately most economists, the Prime Ministers and the Finance Ministers of India either do not understand this simple truth or opt for devaluation of the currency for some hidden motives like external pressure from the US, IMF or World Bank or internal lobbying by exporters.
Devaluation of rupee is not in the best interest of India. The concept of making exports more competitive through devaluation is seriously flawed. It only helps the exporters of the country and the consumers in the developing world. It never helps either the Indian economy or the Indian people. The consumption of any product in the world like tea, coffee, and sugar is finite for a given population.
Increase of exports by one country can only be at the cost of another. The developing nations must learn and understand that mindless competition amongst them is only helping the developed nations get richer and making the developing nations poorer. Developing nations should not fight like street dogs for a piece of meat (the market of the developed world). They must learn to co-operate.
If India, China and Sri Lanka produce 90 per cent of the world tea, they must get together and control production and sale so that they get remunerative prices. If India and Australia produce 80 per cent of iron ore, it is in their interest to co-operate and ensure remunerative prices of their product. The volumes of exports may fall marginally in the short term. But the returns in dollar terms will increase.
We can either opt for over production and deflation. Or we can co-operate and control production and get remunerative prices for our produce as OPEC countries have done in the period from 1999 to 2007 and taken the price of crude oil from $ 14 per barrel in 1999 to over $ 90 per barrel for most of 2007. By this simple manoeuvre, oil exporting countries are piling up their foreign exchange reserves and oil companies are posting record profits.
Keeping the Rupee Strong
To have a strong rupee, the availability of Foreign Exchange must exceed payment requirements. This can be achieved through two methods. One is through manipulation of market forces. The other is by introducing a fixed exchange regime. Let us examine each of them.
Defense Through Manipulation of Market Forces
This approach requires that we try to create market conditions such that the availability of dollars exceeds demand. Foreign exchange is received in different ways. These are: Foreign Investment in the Share Market. This is the hot money that has been the cause of world's economic instability. The less we have this type of foreign investment, the better off and more stable will our economy be.
However, the government and domestic investors are wooing Foreign Institutional Investors (FIIs) as their investment boost markets and reduces Current Account Deficit in the short run.
Foreign Direct Investment: Foreign Direct Investment can be beneficial to the country as long as it does not create surplus capacities and net foreign exchange outflows. It should also not result in unfair competition with domestic industries leading to destruction of Indian manufacturing. Most imports from China are doing just that.
Export Earnings: This is one of the major sources of foreign exchange. However, the slow down of the economies in the developed world eliminates the prospects of increasing exports to the developed world.
Remittances by NRIs and Indians Working Abroad: This is an important source of non refundable foreign exchange. It is a major contributor to balancing our Current Account Deficit and increasing our foreign exchange reserves. There is a need to provide an incentive to get these remittances through official channels. A simple one is to give them a higher conversion rate if the funds are remitted through Indian Banks. In other words Public Sector Banks pay Rs 2 more for a US$ than the rate at which we sell. At present the rates for selling are higher than the rates at which we buy.
Foreign Investments in Indian Government Bonds and Banks: The India Resurgent Bonds, Global Depository Receipts and NRI deposits in banks are examples. These are not earnings but amount to loans and have to be returned with interest at the agreed time. They help to tide over the short term problems but are potential long term problems if they are not productively used to earn foreign exchange.
Market Borrowing: This is foreign exchange borrowed from commercial banks abroad by the government of India, Indian companies and subsidiaries of multinationals in India. These are potentially hazardous unless these loans can generate the foreign exchange required to repay the loan and interest. This was one of the reasons for the collapse of the Asian Tiger Economies in 1997. This type of borrowing requires strict monitoring by RBI.
Export of Services: Export of Information Technology and Business Process Outsourcing services have proved to be major foreign exchange earners. Manipulation of such a diverse set of market forces is extremely difficult if not impossible. Foreign exchange reserves, even if very big, do not ensure a strong a strong and stable currency. Japan has over US $ 200 billion of Foreign Exchange Reserve and a trade surplus of US $ 117.3 billion. Yet it has a weak Yen and violent fluctuations in its exchange rate. If market forces and currency speculation are allowed to prevail, devaluation of the Rupee will continue.
Defending Rupee through Legislation
As we have seen above, the Rupee cannot be defended by manipulation of market forces or by begging for foreign investment. In 1997, Hong Kong spent over 30 billion dollar to defend its currency. India cannot afford to do so. Other countries such as Thailand, South Korea, Malaysia and Brazil also failed and lost precious foreign exchange in trying to defend their currency.
If market forces are allowed free play, the Rupee can be brought to its knee any time if the foreign financial institutions consider it in their interest to do so. When the Rupee begins to weaken, exporters delay bringing in the foreign exchange earned in the hope of making profit. This creates shortage of foreign exchange and weakens the Rupee further.
On the other hand, when the Rupee is strengthening, the exporters are in a hurry to repatriate the foreign exchange earned to avoid loss in conversion. This increases availability of foreign exchange and further strengthens the Rupee. The best way to defend the Rupee is to fix its conversion rate through legislation. There are many options in this regard. We have countries which rigidly fix their exchange rate to the US dollar, SDR or basket of currencies. Hong Kong, Bulgaria, Denmark etc follow this system. Argentina followed this system from 1991 to 2001 when its currency was falling.
China has a crawling peg fixed exchange rate that is decided by its government even though it does not have a current account deficit and a foreign exchange reserve of over US$ 2 trillion. All countries joining the European Union (EU) have to fix their currency conversion rate with the Euro. India should follow the crawling peg system where the fixed rate is changed from time to time at periodic intervals with a view to eliminating exchange rate volatility to some extent without imposing the constraint of a fixed rate.
Crawling pegs are adjusted gradually, thus avoiding the need for intervention by the central bank (though it may still choose to do so). To start with, it can be fixed at its present level. There after we should appreciate the rupee gradually at a rate of half a rupee per month. This will force exporters to repatriate the foreign exchange earned quickly and not hold it back in the hope that the rupee will depreciate. It will also progressively reduce the cost of essential imports. In two years it will reach the rate of Rs 36 to one US dollar. We can fix it at that rate there after.
India is the world's largest market. Investors cannot sit on their money for ever. They have to invest in India. They are trying their best to arm twist India to allow them to invest in India on their own terms. We should not capitulate. We should only allow foreign investment on our terms and in the best interest of the people of India.
The US senate is bringing legislation to stop out sourcing to protect jobs in its territory. We must change over to a crawling peg system of exchange rate and appreciate the Rupee to force exporters and other foreign exchange earners to repatriate their earnings at the earliest. India must learn to act in self interest like the US and China. We must also buy foreign exchange at a higher rate than we sell it. This will encourage remittances through official channels.