The rising rupee, foreign trade & inflation

As the popular saying goes, the difference between a pessimist and an optimist is that whereas the former sees the glass as half-empty, the latter perceives it as half-full. The reality is the same; it is the inference that matters.

Take the figures for the first quarter of 2007-08 in regard to foreign trade. Exporters rightly crib about the lower realisations consequent to the appreciation of the rupee against the dollar - by more than 10% over the same quarter of last year. Imports have accelerated, and may be attributed to the cumulative impact of an economy growing at a robust rate and possibly the lower price tag for overseas goods in rupee terms, which has also fuelled demand.

To those who see these issues in perspective, what is a cause for concern is the sharp drop in the import purchasing power of exports - from 71% to 61% - during the latest three-monthly period over that of the previous fiscal. In another era, the burgeoning trade deficit that has nearly doubled to $21 billion may be viewed as very troubling; now the context is different; with forex assets at more than $200 billion and swelling weekly, we are in a position to make light of it.

However, there is another angle to the steady climb of the Indian currency against the greenback, namely the possibility that its impact on inflation may be benign. In its latest monetary policy review, the Reserve Bank of India drew comfort from the fact that the pass-through effect of monetary, fiscal and supply-side measures, in conjunction with seasonal factors has brought the inflation rate to below the stipulated threshold limit - 4.4% from 5.9% as of end-March 2007. Perhaps this assessment was too laconic to permit an elaboration of the role of strengthening rupee vis-à-vis the dollar in influencing the inflation rate on a downward course. We shall revert to this topic later.

Let us dwell upon the several strands of the issue one by one. Exports have fared badly during the April-June 2007 period, rising by a meagre 7% in rupee terms, though in dollar terms, the growth rate is definitely better at 18%. The setback in terms of rupees is easily explained; the foreign buyer, finding that he has to fork out more dollars to buy Indian rupee-dominated goods, has tuned to other markets seeking price advantage. This has adversely impacted on the export performance. The exporters too are despondent that the declining fortunes of the dollar have meant diminished earnings in terms of rupees. This trend is a distinctive to our export effort and to the realisation of the target of $125 billion set for 2007-08. But gyrations in the forex market must be taken in stride and overcome through conscious drive for quality and cost-cutting to retain and expand overseas markets.

The second point to note is that our imports have maintained a high order of increase during the first quarter of the current fiscal - 34% in dollar terms and 22% in rupee terms. Despite a negligible rise of 4% in oil imports when denominated in dollars -in our currency, oil imports have recorded a negative growth rate -it is the non-oil imports that have really soared - by 50% in rupee terms and much more in terms of dollars. This is possibly a sequel to the high rate of economic growth that has led to a keen demand for capital goods, non-ferrous metals and export-related imports such as pearls and precious stones, chemicals and cashew. With the dollar weakening against the rupee, imports also became cheaper and hence the boom in overseas purchases. Seen in this context, this development is not a cause for worry.

The third fall-out of the firming up of our currency against the dollar may well be the easing of inflationary pressures of late. Unfortunately, the nexus between the two has not been highlighted in the RBI policy statement. In reality, this is quite simple. When the rupee strengthens in the forex market, it means lower prices of imported goods in terms of our currency. In turn, the cost of imported items tends to fall in the home market. They figure as intermediaries, raw materials and capital goods for which, in rupee terms, we pay less now than, say a year ago. Of course, bulk consumption goods like pulses and edible oils too which figure in our imports, for which we pay less rupees per dollar. The cumulative impact of all these factors is the moderation in the inflation rate.
In sum, the strong showing of the rupee in relation to the dollar is not an unmitigated evil as it is made out to be. It is not and the taming of the beast of inflation may be a direct sequel to this trend.

Source - dnaindia.com