Going Upwards: DNA 7th May 2007

Going upwards
The rising rupee is a sign of a healthy economy
Madan Sabnavis
One of our biggest success stories this year has been the appreciating rupee which compares favourably with India being a one trillion dollar size economy. An appreciating rupee means that we need to pay fewer rupees for a dollar. Over the last year, the rupee moved from around Rs 45 to a dollar to Rs 41, meaning an appreciation of nearly 9 per cent. This kind of an appreciation was last seen over a decade ago.
The value of the rupee in dollar terms is based on the total inflows and outflows of dollars into the country. Most of our trade is denominated in the dollar, which still remains the anchor currency in the world. Dollars come in the form of exports of goods, remittances, software receipts, FDI flows, FII investments, NRI deposits and borrowings (ECBs). Outflows are on account of imports, travel, education, repayment of loans, withdrawal of NRI deposits and so on.
Last year, we have seen our exports grow by 25 per cent to touch the $ 125 bn mark. Software receipts would add another $ 28 bn and about $ 25 bn would come from private transfers such as remittances. FDI receipts have crossed the $ 15 bn mark and are close to the double digit level when adjusted for our own overseas acquisitions.
Outflows have been growing at a lower rate despite the widening trade deficit which was around $ 55 bn last year. The net inflows on the whole have resulted in an accretion of $ 45 bn during the year to reach a stock of $ 200 bn. This surge in inflows has resulted in the appreciation of the currency, which would have been sharper had it not been for selective intervention by the RBI. The RBI has been buying up dollars to prevent sharp appreciation ostensibly to provide a boost to exports.
This continuous inflow of dollars can be attributed to two factors. The first is that the Indian economy has been doing exceptionally well with a lot of foreign interest being generated. This has resulted in FDI and FII flows. The software industry has continued its boom thus generating additional dollars for the country.
The second factor behind this resonance in dollar inflows is that the US economy appears to be weak with high deficits and unstable growth. Therefore, foreign funds are looking for other avenues of investment and the emerging markets like India have attractive P-E ratios. Further, the pursuance of liberalization in several sectors such as telecom, trade and banking make the opportunities look even better.
What does a rising rupee mean? We can classify players as being either earners or spenders of foreign exchange. Earners would be worse off as they received fewer rupees on conversion. The 9 per cent appreciation in the rupee actually means a similar depreciation in value of earnings when converted into rupees. Therefore, NRIs, remittances, software receipts would tend to suffer. Exporters would be at a disadvantage because the dollar price would go up. Borrowing from abroad is also no longer attractive as fewer rupees are received. But, continued appreciation will paradoxically make repayments cheaper!
Spenders of dollars would gain because they would have to pay less for a dollar. So foreign goods, travel, education expenses, investments, repayment of loans etc would become cheaper. However, this holds only for expenses in dollars. The dollar has been falling against the euro and pound, which makes these currencies more expensive. Therefore, an inverse relationship exists between the rupee-dollar relation and a rupee-euro/pound relation.
At present, the dollar is falling against the euro, which is also making the rupee stronger. Therefore, funds would continue to flow into India. The same holds for other current account transfers such as remittances and software receipts. NRI deposits, which have slowed down could be expected to accelerate once the US rates are lowered, which is expected soon.
Finally, looking into the future, we can expect the rupee to strengthen based on the expected fundamentals of inflows and outflows. The RBI may mop up dollars to ensure our competitiveness remains. But nevertheless, if one wants to defer a holiday, you may still end up gaining as will one who would like to repay loans at a later date. But, if you want to borrow dollars, do so today to get in more rupees. That, in short is the message of the story.
The writer is Chief Economist, NCDEX Limited. Views expressed are his own.