SUNDAY, AUGUST 5, 2007

Rupee Appreciation & its impact on Indian Economy

From 2003-07 Indian market is booming in leaps & bounds, today after China India
is 2nd fastest growing economy of the world with a growth rate of 9.4% in the first
quarter. It’s a “trillion dollar country surpassed Russia & has become world’s
10thlargest economy, today (till 30th march, 2007) Indian forex reserve is around $200
bn.
Now the hot bubble floating in every Indian’s mind is “Rupee Appreciation”. From
July,2006-May,2007, value of rupee has highly appreciated by 10.7% from Rs 46 to
Rs 40.56. There is a big dilemma in everyone's mind, will the rupee appreciation
adversely effect our economic growth or is it an indicator of Indian growing
economy?
Indian import & export growth rates in March & June 2007 were 34.8% & 18 %
respectively which reduced from April 2007 by 6% & 5% respectively.
In our B-school, it’s a hot issue from various perspectives; academics, market growth
& placements also. Every friend of ours is discussing about it.
Major reasons of this bubble are:

• Huge foreign Investment in our country

• FIIs Inflow

• ECB borrowings

• Slowdown of US economy

In our country there is 70:30 ratio of import & export respectively (data from commerce dept.) in
which major export destinations of India are OCED (USA, EU, Japan) and Brazil & other Asian
countries but a large chunk is exported to the OCED countries.

According to an industry analyst - “Every 10 paisa appreciation in rupee negates

one dollar upward movement in international prices”
From Importers point of view:
“Rupee at nine years high”-

• Oil companies are highly benefited- more than 80% of crude oil is import gulf and other
countries.

According to IOC manager’s statement: “for every Rs1 appreciation crude oil price
dip by 2%”

• Recent acquisitions made by Indian companies’ i.e.

 • UB group- Whyte & Mackay

• TATA steel-Corus etc these companies are benefited.

• International borrowing (from US banks) by Indian companies.

• Beneficial for country external debts because 10% increase in Rs reduce the debt amount by
10%.

Suppose:

US bank/agency-------------------$100 (2006) ---------------------Indian company

borrowing in Rs term= Rs 4600

Given: $1= Rs 46 (July, 2006)

US bank/agency<-------------------$100 (2007) ---------------------Indian company

paying in Rs term= Rs 4000 +interest

Given: $1=Rs 40 (June, 2007)

Here company is getting profit of Rs.600

• Consumer electronic goods, imported apparels etc will be available at cheapest price.

From Exporters point of view:

Around 30% of the exports will surely be affected at one hand. According to
commerce ministry report (Oct, 2006) around 86% of export & 89% import deals
invoiced in USD. So, in this case exports houses will suffer badly.
Major exports houses of India are:

• IT & ITES industry i.e. (Software, hardware & BPOs), Manufacturing industry (Steel pants,
automobile industry, Textile etc), Tourism Industry, Pharma Industry (i.e. Ranbaxy, Cipla
etc),

• Hospitals have (cheapest surgeries compared to US hospitals etc), FIIs etc

• Manufacturing Industry: This industry has also suffered as mainly the customers are US
companies. But as the raw material is also imported mainly(about 70%) in USD, the import
actually has offset the losses due to export to some extent. The loss has forced the industry
to cut it workforce by 11,000.

• Hotel companies (Taj Gvk, ITC hotels etc) are set to loose as 50% of their revenues are in
dollars.

Govt. initiatives to protect exporters:

• Tax incentives, interest reductions, reduction in service taxes

• Export duty reduction & waive custom duty

• Forward contracts will also be beneficial for exports to protect themselves from losses.
Conclusion-

Currencies Year (may, 2006) Year (July, 2007) Change %

Rs in terms of USD 46.2 41.05 11.12%
Rs in terms of Euro 59.05 55.35 6.26%
Rs in terms of Yen 41.1 33.20 19.22%
Rs in terms of 86.55 82.20 5.02%
Pound
According to the given above we can conclude that rupee is appreciating with all
currencies given above which reflects that Indian economy is doing very well,
though it carries with it certain demerits (mentioned above). But these demerits
can be worked upon and transformed into a blessing for the economy.
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Rupee Appreciation To Increase Exporters Profit Margins By

15%

Contrary to apprehensions that Indian exports would decline as result of rupee emerging
stronger but the latest estimates made by the Associated Chambers of Commerce and
Industry of India (ASSOCHAM) reveal that stronger rupee will bring in rich dividends for
Indian Inc and increase its profit margins between 12-15% in long run as exporters are
bringing in new technologies with cheaper imports for expanding their existing capacities.

The aforesaid findings are incorporated in the ASSOCHAM Study on `Impact of Rupee
Appreciation of India’s Exports Vis-à-vis Economy’, clearly highlighting that the balanced
view of rupee getting stronger is that it has already reduced costs of imports and
encouraged domestic manufacturing with technological upgradation. As a result,
capacities expansions of Indian Inc are moving on faster speed which will make Indian
exports much more competitive for developing economies.

“The sectors that are likely to gain a great deal with rupee becoming stronger include petro
and petro products, engineering goods, gems and jewellery, drugs and pharmaceuticals
as these have imported inputs with respective percentage of 77.18%, 21.55%, 92.44%
and 19.41%.

Major impact of rupee appreciation so far has been agro and food processing, auto and
auto components, leather and leather products and cotton, textiles and apparel sector with
respected imported inputs of 11.73%, 13.54%, 15.66% and 10.11%.

The other sectors on which rupee appreciations so far had moderate impact included
drugs & pharmaceuticals with 91.4% imported inputs and engineering goods that had
21.55% imported inputs.

The Chamber holds that a stronger rupee would reduce the cost of imports and would
have some positive impact on those exporters who have large import contents which is
 totally justified with figures mentioned above, further says Mr. Dhoot.

The ASSOCHAM Paper has recommended that if companies are able to expand, their
capacities in the rupee appreciating scenario, they would in the long run, definitely be in
win-win situation because demand or Indian products in developed countries is not going
to slowdown. The Indian Inc. would be able to export more at very competitive prices as a
result of capacity building through technological advancement and increase its margins by
10-15%.

However, a substantial part of Indian exports like gems and jewellery, petroleum products
etc. have large import contents. These commodities would derive some benefit from the
appreciation of the Rupee. Even if the price of petroleum products shoots up in the
international market, the benefits of a lower cost of import due to stronger Rupee would
percolate down to the exporters. A stronger rupee would also reduce the cost of imports of
machinery and technology and in the long run these would have positive benefits for the
Indian manufacturers.

One area where India competes with the global developed markets as also the emerging
markets is in regard to export of computer software. The appreciation of the rupee, in the
longer run, is going to affect the IT services sector also. However, through adjustments in
margins and higher efficiency and prudent hedging of exposures, this sector may be able
to overcome such adverse situation.

The Chamber Paper further points out that the appreciation of the rupee has to be viewed
in the background of the higher level of inflation prevailing in the recent past. While a
stronger rupee would have a negative impact on export growth, one would also need to
understand that over a period continuing higher inflation would ultimately lead to rise in
domestic price of commodities, which are essential inputs for exporters. This would also
indirectly reduce export competitiveness in the global markets even with a stable
exchange rate. On balance, the appreciation of rupee has its positive aspects as well.

ASSOCHAM believes that while one would have to accept that sharp appreciation of the
rupee in a short span of time would have its effect on the country’s exports but one would
have to live with fluctuations of exchange rate, the contours of the global markets are
changing, target markets are now wider and diverse.

The Chamber has taken a position in its latest Publication that demand for Indian exports
in developing countries is not going to slow and the impact of rupee appreciation will
remain confined to sectors that are domestically driven.

Equally important is to address the various other issues such as finance, transaction costs,
delays, simplification of documentation and better infrastructure etc. It would also be seen
that even during periods of appreciation of rupee the export growth has remained
buoyant.

Annual Report 2007-2008

Back
Impact Of Rupee Apprecation On India's Export
(With Sepical Focus On Labour Intensive Sectors)

Indian exports enjoyed the advantage of slow depreciation of currency during the period of mid-2005 to mid-2006.
Rupee showed a turn around since August 2006. In terms of Real Effective Exchange Rate (REER), it rose steadily
between August to November 2006 and slipped slightly thereafter. From March 2007 onwards, Rupee experienced
a rise in its value. As per REER (Graph 3.1), rupee has appreciated by almost 8% during March to May 2007.
Appreciation was much higher against US Dollar compared to Euro. Another round of appreciation is visible
 between August-October 2007, which has been relatively mild. REER provides the trade weighted average change
in exchange rate vis-à-vis major currencies. Hence, the appreciation rate as reflected in REER provides a combined
pictureof how Indian Rupee got appreciated in recent times.

Rupee got depreciated during July to October 2005 and then February to August 2006. In Rupee terms, monthly
exports grew by 51% and in US Dollar terms monthly exports growth rate was 41% during this period July to
October 2005. In the entire period of 2005-06, exports grew by 23.44% in US Dollar terms and touched US $ 103
billion. In terms of Rupee, growth was around 21.6% and total exports in 2005-06 were Rs.4.6 trillion. During the
period 2006-07, India’s exports grew almost by 22.5% in US Dollar terms and total exports reached to US$ 126
billion. In Rupee terms, growth was 25.3% and total exports were Rs.5.7 trillion. Impact of changing values

of currency on exports has not been significant during 2005-06 and 2006-07 as both the periods were marked by
appreciation as well as depreciation of currency which played an overall neutralizing role. Moreover, impact of
appreciation of Rupee on exports requires at least four to six months time to get realized.

Since April 2007, as there has been sharp rise in the value of Rupee, there is a severe impact on the export growth
rate (Table 3.1). The cumulative exports during the period April-October in 2005 was US $ 57 billion (Rs. 2.5
trillion) which increased to US $ 71 billion and (Rs.3.2 trillion) in April-October of 2006 registering a growth rate of
almost 24.4% in US Dollar terms (30% in Rupee terms). The cumulative exports during April-October of 2007
have been US $ 85.5 billion (Rs.3.5 trillion). In US Dollar term the growth was around 21% but in Rupee terms the
growth declined to only 7% implying a serious blow in terms of rupee realization of Indian exports.

In case of imports, cumulative value of imports for the period April-October, 2007 was US $ 130 billion (Rs. 5.3
trillion) as against US$ 103.7 billion (Rs. 4.8 trillion) registering a growth of 25.31% in Dollar terms and 11.07% in
Rupee terms during the same period of 2006. The import growth rate for the same period in 2006 over 2005 was
26% in US Dollar terms and 32% in Rupee terms. Slowing down of import growth in 2007 has been mainly
because of less growth in POL import. This has proved that India’s import has not increased significantly despite
the fact that Indian rupee has appreciated significantly in recent months. In fact, slowing down of import growth
rate implies that India’s import is less elastic with respect to exchange rate.

Currency Appreciation and Export Value: Recent Experience

In 2006-07, India witnessed large trade deficits to the tune of US $ 65 billion and current account deficit was as
high as US $ 10 billion. The level of trade deficit should have been enough to depreciate the rupee, as supposed in
traditional exchange rate theories. However, interest rate cuts by the US Federal Reserve led to higher inflow of
portfolio investments into the country resulting in unprecedented and continuous rupee appreciation. Foreign
portfolio investment recorded an inflow of US $ 20.7 billion during April-July 2007. FDI inflow was also significantly
high and recorded US $ 6.6 billion during April-July 2007 (US $ 3.7 billion in April-July 2006). Large inflow reflects
expansion of domestic activities, positive investment climate, and positive view towards India as a long-term
investment destination. All these have raised an upward pressure on Indian Rupee (INR).

Table 3.1

India’s Exports vsi-a-vis Exchange Rates

 India’s Exports to World Average Value
Period (Rs. Million) (US $ Million) Rs. Per Euro Rs. Per US $
Apr-Oct 2005 2,494,969 56,928 54.09 43.81
Apr-Oct 2006 3,250,912 70,838 58.03 45.86
Apr-Oct 2007 3,477,939 85,583 55.73 40.68

Source: Calculated from India Trades, CMIE

Rupee depreciated steadily for a decade after being floated in 1993, dropping from an average annual rate of Rs.
31.37 per US Dollar in the 1993-94 fiscal year (April-March) to Rs. 48.40 per US Dollar in 2002-03 (an average
annual depreciation of nearly 5%). From 2003-04 to 2005-06, however, the rupee appreciated against the US
Dollar by 3% on average a year. But the rate of appreciation of Indian Rupee has been unprecedentedly high from
July 2006 till date, falling by about 16.3 % (46.97 to 39.25 per US Dollar). The average rupee-US dollar rate in
November 2007 was the lowest since 1999-2000.

On the other hand, though the Indian Rupee appreciated against Euro, Pound Sterling and Yen also, the rate of
appreciation has been much lower. Moreover, the upward rallying of rupee against these currencies more or less
leveled off since May 2007, though there have been high fluctuations in weekly movements. Against Euro, Indian
Rupee shows a slight but steady depreciation from July onwards. The trend of exchange rate vis-à-vis US Dollar
and Euro is given in Table 3.2 and Graph 3.2 and 3.3 below.

Table 3.2
India’s Exchange Rate

Source: Reserve Bank of India

Graph 3.2
 Source: Monthly exchange rate available in India Trades, CMIE and RBI

Source: Monthly exchange rate available in India Trades, CMIE and RBI

The current upward rallying of Rupee evidently is a natural outcome of India’s robust economic growth over the
last decade. With low interest rates in US, India and other emerging markets are becoming increasingly attractive
as an investment destination for US and other countries. As more and more Dollar flows to India, its supply
exceeds demand and result in depreciation against Indian Rupee. As most of India’s trade is through US Dollar,
continuous appreciation of Indian Rupee against US Dollar has a significant impact on exports. Exports through
Euro were unable to balance the loss incurred in exports earning through US Dollar.

Graph 3.4 below explains the dynamics of India’s export growth. Export values in terms both Rupees and US Dollar
are described in the diagram. Rupee values are measured on the left hand vertical axis and values in US Dollar in
right hand axis. The average monthly growth (calculated through CAGR) of exports during April-September in 2006
was 4.54% in US Dollar (5.08% in Rupee terms). Higher growth in Rupee terms compared to US Dollar implies the
advantage of depreciated currency in realization of exports. The monthly average growth rate during the same
period of 2005 was 2.07% in US Dollar (2.15% in Rupee). However, during 2007, though exports were growing
but decline in growth rate is very much visible. In the period April-September of 2007, Indian exports grew by 3%
per month in US Dollar and in terms of Rupee the rate was 2.15%. Lower growth rate in rupee terms compared to
US Dollar shows that due to appreciation, the export income in Rupee is slowing down.

The growth of India’s exports in 2006 was both due to fast growth of world exports as well as due to its
depreciated currency. In 2006, according to WTO, world export growth was around 8%. Export growth may slow
down to 6% in 2007 due to moderate deceleration of World economic growth. Hence, slowing down of Indian
exports is also partially due to slow down of world demand in 2007 and not completely due to Rupee appreciation.
Also it is important to note many other currencies have shown the tendency of appreciation (Graph 3.5) and as a
result competitive disadvantage of Indian exports due to appreciated currency have also partially
neutralized. Some of these countries have given extra thrust in increasing productivity and perhaps India is loosing
its advantage due to that. The rise in world merchandise exports in 2006 was also due to global inflation. Almost
40% of exports value was due to this price effect. As the world inflation slows down, the extent of price effect will
also come down in the export market. This might have contributed to slow down of India’s export growth also.

Graph 3.5
Dollar changes vis-à-vis selected major currencies, 2001-2006
(Indices, January 2001=100)

a. Trade weighted currency basket of the Korean won, the Singapore dollar and Chinese Taipei dollar.
Source : http ://www.wto.org/english/news_e/pres07_e/pr472_e.htm

Effect on Labour Intensive Exports

Rupee appreciation affects different sectors, differently. High-import intensity sectors like automobiles, petroleum
products, gems and jewellery, fare better in face of a stronger rupee as appreciation renders their imported inputs
to a lower value. However, the appreciating rupee could significantly erode net profit margin of low-import
intensity sectors like textiles and leather, as exporters of these sectors remain in a disadvantageous position
especially in price sensitive international markets. Many of the low-import intensity sectors also operate with very
low margins, making them feel the heat of rupee appreciation more. The impact on employment is also directly
related to the factor intensity of production both in the export units as well as in the input sector. An analysis of
this is given in Table 3.3.

If the input sector is labour intensive and export units use largely imported inputs, employment in input sector will
get the hit as they will be replaced by cheap foreign inputs. This implies that even though high import-intensity
sectors benefit from the appreciating rupee it does not necessarily mean that in the longer run the economy, as a
whole, will be benefited.
 Continued rupee appreciation could have a long lasting impact on employment as most low import-intensity
sectors are highly labour-intensive and they lay off labour quickly as rupee appreciation erodes their profitability.
Also

Table 3.3

Impact of Rupee Appreciation on Exports and Employment

employment in import-competing industries may get hit later on. Job losses were already reported in certain
sectors, such as textiles and leather. The strain on the labour market became visible ever since last year when
number of registered job seekers in the country shot up by more than 2 million to 41 million. Significantly, the
increase came after two consecutive years of decline in registered work applicants.

The software exports sector also gets affected by the long-march of rupee. Indian IT companies derive a large
share of their revenues from the US and a strengthening rupee erodes their margins. Software industry body
NASSCOM contends that there has been ‘too much rupee appreciation in too short a time’, making small and
medium IT companies to be the hardest hit. Industry sources state that a one per cent rise in the rupee value
would affect bottom-line of the IT and BPO sectors by 30 to 40 basis points.

While the full impact of the negative growth on employment will be assessed by the end of the financial year, the
reports from industry and trade associations and exporters indicate that if this trend continues, by March 2008, the
total job losses may exceed 2 million.

A limited survey conducted by the Regional Authorities under DGFT covering 83 units including leather, textiles,
engineering, plastics, marine products, pharmaceuticals, chemicals, agriculture and food processing, electronics
and handicrafts and carpets has shown a job loss of 20,769 between April-November 2007.

Impact on Textile Sector

Textile is an important sector in India’s export basket. This sector has negligible use of imported inputs and is
employer of large number of people in India. Rupee appreciation has indicated loss in export growth both in textile
 as well as in readymade garment (RMG) sector. Graph 3.6 and 3.7 provides trend picture of exports from this two
sectors. A comparison between April-June in 2006 and 2007 reveals that textile sector exports dropped by 0.66%
in terms US Dollar (by 10.13% in rupee terms). The decline in RMG exports has been more severe. The exports fell
by 4.21% in US Dollar terms and by 13.19% in Rupee terms.

Graph 3.6

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

At product level, steep decline is observed in case of cotton apparels which have share of 80% in total apparel
exports. In case of woven category, decline in exports are also observed. RMG exports fell by more than 10% in
USA market which comprises of 31% of the market and by only 4% in EU market having share of 45% of total
RMG exports. Clothing sector is highly labour intensive. An investment of Rs.100 million generates 500 direct and
200 indirect jobs. Around 5.8 million people are engaged in apparel industry. Due to slowing down of the export
growth, employment generation will be mere 12% of what has been targeted. In fact in many sub categories, job
losses are already reported. It is estimated that for every percentage point of appreciation, profitability of exports
in textile sector is hit by 1.2%.

Impact on Leather Sector

Graph 3.8 below shows that leather exports have fallen mainly at the beginning of the year, which may be due to
early appreciation during the October to January period. During April-September, exports have increased.
However, in rupee terms export grew only by 4.84% (in US Dollar terms by 16%) implying erosion at the time of
realization of exports in Rupee.

Over 65% of leather exports are invoiced in US Dollar. The problem is compounded as most of the Indian
exporters cater to the lower end of the global market where penetration is directly depended on the price lines
offered by the exporters. Moreover, several American Brands operating in Europe prefers to trade with US Dollar
than Euro and hence leather exporters are unable to switch to euro to shield their losses. The manufacturing units
in the leather sector are more or less compartmentalized as one serving the global markets and the other domestic
markets. In view of this arrangement, exporters have no set up or experience to sell their products in the domestic
markets. Thus, when the rupee appreciated almost to 12% in a shorter time exporters had no other alternative but
to start reducing their production and think in terms of lay off of the employees.

Graph 3.7
 Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Graph 3.8

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Leather exports are significantly dependant on orders from the foreign buyers. Accordingly most of the
employment offered by the sector is either unorganized or in form of contract employment. Due to the current
Rupee appreciation, exporters are unable to negotiate prices with big buyers which resulted into smaller orders and
this in-turn has caused loss of employment to the people working on contract basis or in unorganized sector. More
than 94% of the manufacturing units serving the export markets are either small or medium sized ones. These
units operate on thin margins and depend heavily on own funds for working capital as access to institutional
finance is cumbersome or need collaterals. When the export realization has reduced, it not only wiped out the
margins but also reduced the working capital. This led most of the exporters in to a vicious cycle of debt-low
productivity.

Impact on Gems and Jewellery

The sector is highly labour intensive but at the same time import intensity is equally high. Exports in this sector
have produced spikes with upward trend since mid 2006. There was big drop in exports in November 2006,
February and April 2007. Details of this are described in Graph 3.9 below. The sector has experienced a rising
export trend during the period April-June 2007. Comparing the same period in 2006, exports in 2007 has grown by
27% in US Dollar terms and 15% in terms of Rupee. However, exports in Rupee having relatively slower growth
imply that sector is not immune from the rupee appreciation despite having high import intensity. This is mainly
due to the fact that exporters were unable to neutralize risk considering a forward contract. As rupee has
appreciated after the contract has been signed, exporters lost in terms of actual value received. The industry is
significantly driven by SME players who operate on a thin margin of 3-6%. Loss in realization of export values
while converting into rupee has eroded their margin significantly. The industry requires large working capital in
view stocking of important raw materials and finished goods. Erosion of export earnings has also created a strain in
terms of availability of working capital.

Graph 3.9

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Impact on Handicrafts Sector (Excluding Handmade Carpets)

Handicrafts are highly labour intensive products but pricing of handicrafts are difficult to explain by market forces
completely. The intrinsic values of handicrafts are such that price depends on many non-market issues. The export
market of handicrafts products is a reflection of this. Graph 3.10 below explains the fluctuating trend of Indian
handicrafts exports. It dropped significantly in July 2006 and rose again in September and fell thereafter. The
cumulative exports during April-June 2006 were around US $ 110 million (Rs.5017 million) and it dropped to mere
US $ 64 million (Rs.2610 million) during April-June 2007 reflecting a major erosion of export income both in terms
of Indian Rupee and US Dollar. It is also important to mention that due to the time gap between contract, delivery
and payment, exporters are bound to have been affected as Rupee appreciated so sharply within such a short
time. As large numbers of rural and poor artisans are dependant on handicrafts products and most of the time they
do not have fixed wages and they sell their products at piece-rate, any short fall in the export market affects them
severely.

Graph 3.10

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Other sectors such as engineering goods, forest products, sports goods, chemical products agro products such as
 tea, rubber, coffee, etc. are also affected by rupee appreciation but the degree of injury is varying.

Other Contributory Factor to the Slowdown in Export Growth

Infrastructure bottlenecks acts as additional contributory factor to the slowdown in export growth. The high power
costs and the erratic and inadequate supply of electronic power have adversely affected the competitiveness of
Indian exporters especially of small and medium enterprises. The Indian ports take a turn round time of 3-5 days
as against only 4-6 hours at other international ports like Singapore and Hong Kong. As far as internal transport is
concerned, the secondary roads and inter-state checkpoints are still needed to be improved further. Time taken for
transportation of goods from the production centres to the port of export is an important factor in determining the
cost of transaction. Due to various provisions governing inter-State movement, lot of time is wasted at the intra-
State and inter-State checkpoints/ borders while good are moved through road transportation. With the growth of
trade and increase in number of consignments, there is a need not only for improved trade infrastructure facilities
to international standards but also for streamlining trade data infrastructure to remove any data anomalies and
provide the basis for appropriate policy formulation.

Full neutralization of taxes needs to be ensured so that Indian exports do not become uncompetitive in the
international market. The present system of neutralization of taxes through the Duty Drawback and Duty
Entitlement Passbook Scheme do not take care of neutralization on account of State taxes like octroi, mandi tax,
electricity tax, etc. which is another contributing factor to the slowdown in export growth. While re-imbursement of
inputs services used in manufacture of export products is possible through CEVAT route, there is no mechanism for
reimbursement of post-production export-related activities/ services obtained like service tax paid to foreign
countries, inland haulage charges, commission paid to agents etc. thus adversely affecting the competitiveness of
Indian exports. The small manufacturers who are either in non-excisable sectors or are exempted from purview of
excise duty have to bear incidence of service tax paid during course of exports. This makes their products
unproductive. Though there is a provision of refund under the VAT Act, which came into effect from 1st April 2005,
the refund mechanism is yet to be operationalised in most of the States and exporters are facing problems on this
account.

Government Initiative and Strategy Options

Dr. C. Rangarajan, Chairman of the Economic Advisory Council to the Prime Minister has been requested by the
Prime Minister’s Office to look into and offer suggestions on the measures sought by the Department of Commerce
for mitigating the adverse effect on the exports arising out of the appreciation of the rupee. The National
Manufacturing Competitiveness Council (NMCC), headed by the Dr. V. Krishnamurthy has been directed by the
Prime Minister’s Office to further examine the measures and make appropriate recommendations to the competent
authority for necessary implementation.

As India’s exports are getting affected, government of India has also taken several steps to neutralize the effect of
rupee appreciation. Government announced a package in July 2007 which is mainly in the form of providing
several incentives to exporters and enhancing some of the existing ones. The package includes enhancing of DEPB
rates, duty drawback rates, decrease of ECGC premium, pre and post shipment credit interest rate, etc. To clear all
arrears of terminal excise duties and CST reimbursement, an amount of around Rs.6000 million has been released
by the Ministry. The government has also announced the exemption of Service Tax paid on post production export
of goods. The exemption is allowed on some taxable services, which are not in the nature of “input services” but
could be linked to export goods. However, some exporters are of the opinion that this incentive may be extended
to service tax paid by exporters to foreign agents, movement of goods from factory to port/ICDs, on bank charges
etc.

Apart from this, RBI has also announced to provide interest subvention of 2 percentage points per annum to all
scheduled commercial banks in respect of rupee export credit to the specified categories of exporters mainly which
have labour intensive production technique and less import intensity in terms of input use.

Several organizations have also provided suggestion to government and currently they are being studied. Some of
the suggestions are as follows:

• Funds in EEFC account may have the interest rates at par FCNR
• Separate refund mechanism for state level taxes
• Introduction of EXIM Scrips
 • Separate export working capital fund which will be available to Bank at a cheaper rate etc.

RBI also has taken up several monetary policy measures which have some impact on the system especially on the
value of Rupee. On July 31 2007, RBI raised the cash reserve ratio by 50 basis points, to 7% in order to drain
liquidity from the system and thereby to handle inflation. At the same time it lowered the amount of money raised
from external commercial borrowing that can be converted into rupees. It is expected that this will reduce the
capital inflow and dampen the pace of Rupee appreciation. Central Banks of other countries where domestic
currencies have been appreciating also take similar steps. The whole range of instruments include direct
sterilisation through issuance of government or central bank bonds, increases in reserve requirements, and
different means of capital account management to manage the monetary impact of excess forex flows.

Firms are also required to handle their foreign exchange with due care. As India is gradually getting integrated
with the world economy, currency volatility will become a normal affair. It is important to mention that firms are
enjoying several incentives for quite sometime but there is a big question about converting these incentives into
productivity gain. Loss due to currency appreciation may partly be neutralized with lower cost of production
emerging from higher productivity. Within industry also, the effect of rupee appreciation varies among firms. More
productive firms can absorb the loss in a better way. Also, due to volatile currency market, firms need to learn
sophisticated methods of risk management.

Short term strategies of firms will be to use forex derivatives like forward contracts, options swaps and futures.
Use of derivatives ensures the profit margins for cash inflows or outflows of foreign currency business transactions.
Forwards are very useful for exporters especially in case of US Dollar has premium for forward values and is
depreciating against Rupee. Exporters may use forward contract to switch the invoice currency into strong
currencies by paying nominal charges without bothering the foreign buyer to change the invoice currency.

Medium Term strategies mostly cover operational efficiency to hedge currency risk. Such approach covers internal
matching of exposures by netting currency assets and liabilities, currency risk sharing clause in sale & contract,
structured financial deal to reduce cost of borrowing etc. Analysis of cost portfolio is also essential. In the medium
term, firms must start looking into the issues related to value addition of products and not just the cost arbitrage
Exporter while considering a market entry, develops promotional strategy taking into account the anticipated
exchange rate changes. Appreciation of rupee will adversely effect allocation of funds for such activities as
compared to their competitors in international markets. Cost reduction will help to maintain promotional budget for
business development.

Long term strategy of firm must focus on protection of foreign market shares, updating the product to reduce price
sensitivity, making attempts for brand development and broaden the markets. Companies have to respond to
exchange risk by altering their product strategy covering product innovation and new product introduction based
on R&D. Constant improvement in product by following creative destruction of old product is required for survival
during the time of strong rupee scenario. Quality of the product and service must be of world-class to win trust of
overseas buyers. Companies also need to allocate sufficient funds to train employees about nuances of
international business environment including risk management.

ANNEXURE
 Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Processed Foods include processed fruits and juices, Processed vegetables Meat & Preparations and miscellaneous
processed items
Source: Calculated from Principal Commodity Exports, India Trades, CMIE

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The US dollar – rupee exchange rate is the current hot topic for discussions amongst economists. The 15 per
cent (almost) appreciation of rupee over the last year has given way to many issues and arguments
regarding its effect on the Indian economy and its different sectors and also its effect on the labour and job
market. All the major currencies across the world have witnessed a rise in their value vis-à-vis the US dollar.
The Canadian dollar appreciated by 23%, euro by 14.7% and the pound rose by 10.4%.

Appreciation of Indian rupee (which appreciated by almost 9% between January and June this year) is being
cited as the result of the increasing capital inflows and the RBI’s effort to intervene in the increasing inflation
rates. But the contradiction is that the stronger rupee is having

a gloomy effect on various sectors especially the labour intensive industries like leather and handicrafts
based in the tier-II cities of India. The appreciation of rupee has badly hit India’s exports (mostly to the US),
and as a result many organisations export units have already shut down or reduced their staff considerably.
We shall now discuss the effect of the same on different Indian industry sectors:

TEXTILE & APPAREL industry

Indian textile industry – which held a competitive position in the apparel and textile export to US-has been
adversely affected by the appreciation in the value of rupee. The industry is witnessing a decline in the
domestic textile and apparel export to US in the first half of year 2007. Although the total imports BY the US
witnessed an overall increase by 5.70% over the last year, exports by Indian textile and apparel saw a decline
by 0.21 %. The industry which was already facing sluggish apparel sales in the US has been hit by the
strengthening position of rupee against the US dollar. The worst affected is the labour force of the industry.
Approximately 10 lakh workers are feared to loose their jobs due to the current scenario of the rising value of
rupee. Also, as many as 80 lakh workers are expected to be indirectly affected by the prevalent situation. The
fear of loosing their jobs is gripping the entire industry, right from the organisation owners and the small
scale workers. Many small scale units in tier – II cities have already faced the brunt and have shut increasing
the unemployment in the sector.

IT industry
India has emerged as the most preferred and low cost destination for outsourcing the IT products and
services. India has the advantage of providing services at low-cost because of the availability of the
engineers and the developers. The last year has seen the Indian rupee strengthening against the dollar, the
average salary in the IT industry has risen considerably and, the East European and other Asian countries like
Japan are also giving tough competition to the Indian IT industry. The short term impact of all these situations
can already be seen in the industry with the diminishing profits of the industry. Also, the appreciation of
rupee has led to decreasing number of projects and assignments. In recent years, the Indian I industry has
grown at a very fast rate. Even if the sector maintains the growth rate, the profit margins of Indian players
will only get lesser because the appreciation of rupee is eating away the purchasing power of dollar. The
lesser profits would also affect the investment in training and development of professionals, the
infrastructure and the common practices of the industry requiring heavy investment. The worst effected will
be the small players in the industry as rising costs and salaries and decreasing profits will be difficult for them
to manage. All these factors can have adverse effects on the labour force of the IT industry.

LEATHER industry
The same is the case with the Indian leather and handicrafts industries. Kanpur and the adjoining areas is the
hub of India’s leather trade and US exports account for nearly half of the region’s leather trade revenues. The
rise in the value of rupee has eroded almost all the profit margins of the exporters made from US shipments.
Most of the companies have stopped taking fresh orders and decreased the number of employees as well as
the number of shifts of the remaining employees. Wilting under the financial debts, many units have already
have shut their business and with no new assignments coming their way, the remaining functional units are
also almost out of business. The Brassware export business in UP and the handicrafts industry are also
loosing their business to countries like Sri Lanka, Pakistan, Bangladesh and even China, which are providing
lower costs than India to the importers in US. The large agricultural and industrial base of India is being badly
affected by the rupee appreciation. The extent and the long-term effects of the damage are yet to be seen. If
the rise in the value of the rupee continuous, it will erode our competitiveness against countries like
Bangladesh or China.
Effect of Rising Rupee vis-a-vis US dollar on Indian Economy
The US Dollar has fallen w.r.t. Indian Rupee by more than 20% over last one year. We
need to understand as to what effect this will have on Indian Economy. Some of effects
are already visible; such as -
1. Indian Five Star hotels are accepting their charges in Rupees and not in dollars.
2. Imports have become cheaper.
3. Indian exporters are loosing money as Indian goods and services are becoming costlier
for importing country.
4. The Indian immigrants are finding that their overseas jobs are no longer rosy.
5. Foreign remittances have depleted.

Introduction: Rise of the Rupee against the Dollar

The Indian rupee has been witnessing a continuous rise in its value against the US dollar. An increase of
approximately 13.5 % has been witnessed in the last one year.

This appreciation in rupee value is proving to be dangerous for certain industries, of which the textile industry is the
worst affected industry.

Industrialists and experts, particularly exporters, seem worried over losses due to rupee appreciation. Exporters are
experiencing a significant amount of reduction in exports, specifically in garment exports. Adding to their difficulties,
there is little or no rise in the currencies of their close competitors like China, Bangladesh, Indonesia and Pakistan.
For example, China's Yuan has gained only 4.72% in the last year as compared to the Indian rupee. The following
chart shows changes in different currencies against the US Dollar.

To get in-depth idea about "Effect of Rupee Appreciation on Indian Textile Machinery Industry"
Fibre2fashion.com had carried a survey of industry leaders. Through this article we have tried to
highlight and summarize their views on effect of stronger rupee, expectations from government
and current strategy of their company.

Effect on the Textile Industry and Exports

Mr. Sridhar Varadaraj - Chairman, Textile Machinery Manufacturers Association (I) states, The
health of the Indian textile engineering industry (TEI) depends on the condition of the Indian textile industry. The
Indian textile industry has been hard hit the appreciation of the rupee to the extent of 15% over the period of the last
one year. In their latest press release, the Confederation of Indian Textile Industry (CITI) requested the Government
to come to the rescue of the industry by announcing relief measures to offset at least a significant part of the losses
that the industry is suffering because of rupee appreciation and interest escalation. The units across the textile value
chain are getting closed or scaling down operations across the country because of the losses suffered, both in the
domestic and export markets. A large numbers of workers have already lost jobs in the process and the situation is
worsening week after week.

There has been a decline in export growth from 16.6 % in 2005-06 to 9% in 2006-07 Large-scale loss of jobs is close
on the heels of this export growth decline. The amount is approximately Rs. 1.22 lakh.

Appreciating the causes and effects of rupee appreciation

The rupee’s appreciation is good so far as the diagnosis goes. The problem is how to cure the disease.

S. Venkitaramanan

The recent weeks have seen the rupee rising against the dollar amidst squeals of
protest by exporters of textiles and other manufactured goods, besides services.
Software services have, particularly, seen their competitiveness suffer. Importers of
goods and services may have benefited because of the decline in the rupee value of
goods and services imported. But this can lead to protests by competing Indian
manufacturers located in India. The Government has responded somewh at
reluctantly by offering a package of tax incentive and interest reductions to exporters.
While these steps are, no doubt, welcome, they are not as easy to effect
competitiveness as exchange rate intervention resulting in a devalued rupee. Not for
nothing is China resisting the US pressures for revaluation of its currency.

The RBI is caught on the horns of a dilemma. It stopped aggressive intervention in

the currency market because of the adverse effects noticed as a result of its injection
of liquidity by sale of rupees in exchange for forex. The supply of excess domestic
currency leads to inflationary pressures unless offset by sterilisation, which means the
central bank would have to sell debt paper of Government to the banks to suck out
the additional rupees. Unfortunately, sterilisation has its costs. It increases the supply
of debt paper leading to a fall in their price, which is the inverse of interest rate.

The net result of successful intervention and sterilisation is rise of interest rates,
which, in turn, leads to further capital inflows — a vicious cycle. So, Indian banks
return the compliment by countering the effects of sterilisation by investing further in
government debt, unlike their Chinese counterparts that cooperate with their central
bank in achieving the desired effects of sterilisation. All in all, a messy situation! To
counter the inflationary effects of capital flows, the central bank sterilises the flows,
which only leads to further capital inflows.

Impact Unclear

The debate between the advocates and opponents of intervention has been long on
argumentation, but weak in conclusions.

The latest RBI Report On Currency and Finance devotes considerable space to
analyses of research papers on the subject of effectiveness of sterilised intervention.
While the technical details are, no doubt, interesting to academics, the policy
implications of the debate are not clear. It is not definite whether sterilised
intervention does at least succeed in reducing the volatility of the exchange rate,
although it has resulted in reducing the monetary impact of the liquidity surge.

While the debate goes on, the adverse effects on manufacturing industries as well as
services are, indeed, grave. The sops offered by the Government and the banks are,
no doubt, well-motivated. But the market has already discounted their effects. What
is material in the export market is the offered price of the products. This remains
higher than that of competition’s.

The RBI and the Government will have to have a look at whether their policy options
are limited to either intervention or non-intervention. Can the RBI not think of
imposing a cap on capital inflows of a particular hot-funds type — a la the response of
some Latin American countries? Of course, bourses and businesses may react
adversely.

To the extent we depend on capital flows for meeting our current account gap, our
position will become more vulnerable. But there has to be a way out of the problem
other than that which inevitably results in curtailing our export competitiveness.

Self-Defeating measure

It is, of course, desirable to liberalise capital outflows by Indian residents, but beyond
a point, the measure can be self-defeating. The outflows can become a flood. I feel
the RBI has its task already well cut out to manage the large capital inflows. If to this
we add the problem of capital outflows on an unregulated basis, the RBI’s task will be
nightmarish.

Voices have been heard comparing the manner in which Japan faced its problem of
appreciation of the yen in the 1990s from nearly 230 yen to a dollar to around 130.
Japan did so by improving its productivity and introducing product innovations. This
is, of course, a challenge which Indian industry has to wake up to. But that requires a
host of other enabling factors. Infrastructure, for instance, is an important bottleneck.
But the solution to that problem is difficult and of long gestation, even given the
attention at the Prime Minister’s level itself. Apart from this, there is the emerging
issue of lack of adequate skilled manpower. This calls for provision of more education
and training facilities. The problem of a dearer rupee can be solved only by a
multifaceted attack on many fronts. This, of course, requires Government to take
action on many aspects.

Ultimately, the RBI can only work with the tools at its disposal within a given global
framework and a political environment not of its own choice. To control capital flows
— in both directions — is against the current sentiment in favour of capital
convertibility. At the same time, allowing capital inflows or outflows unregulated
threatens the sustainability of the fiscal stability. The solution may lie in a
combination of intervention with fiscal action to support or manage the price of
essential commodities and at the same time encourage exports by tax sops.
Obviously, this is precisely the blend the authorities have served up now.

A more sophisticated approach is, however, not beyond the capacity of the whiz kids
of Mint Street and North Block to evolve. The price may be higher in terms of fiscal
deficit, but one cannot obviously have exchange rate stability, low inflation and fiscal
responsibility at the same time. This is the classic trilemma of monetary fiscal
management in another form.

Too Complex?

In this context, I recall a reference to the exchange rate of the rupee in Oscar
Wilde’s Importance of Being Ernest. In the play, the elderly governess advises her
ward to lay aside the chapter on the Indian rupee as it is too complex. That discussion
obviously referred to a time when the richer classes of Great Britain were worried
about the value of their Indian stocks, which was denominated in rupees. Their fear at
the time was of the rupee depreciating against the sterling. Now, the tables are
turned; the rupee is appreciating. An Oscar Wilde of today will be well-justified in
repeating the warning that the rupee’s gyrations are, indeed, too complex to
understand, but in a different direction.

The RBI Governor and the Finance Minister have to fight with the harsh reality of
economic and political life. “The unpleasant consequences of a bulge in the resources
flow on the capital account are easily appreciated;” the disease is easy to diagnose.

The appreciation of the causes of appreciation of the rupee is good so far as the
diagnosis goes. The problem is how to cure the disease — of abundance of riches —
without hurting the patient — the Indian industry and the economy. Both North Block
and Mint Street have to work together to solve this trilemma.