Monetisation is key, not exports data: Economic Times 17th October 2007

A major concern today is the appreciating rupee as it has created a dual problem of affecting exports and creating monetization issues for the RBI. The situation is not very different from what the Euro zone is facing where the Euro is strengthening against the dollar, albeit more freely, and the fear of loss of competitiveness lingers. It is the same feeling in India too with the exporters getting worried that their competitiveness will be eroded in case the rupee continues appreciating.

But, surprisingly so far, the rupee appreciation has not quite led to a fall in exports and the present growth rate is steady at a high level of close to 20%. But, the exporters are saying that this growth would not be sustainable in the face of an appreciating rupee as they are compromising on profit. There is again talk on the various options of hedging for the exporters. The RBI on the other hand is trying hard to control this appreciation but is having a problem with excess monetization and the issuance of new MSS bonds.

In this context it would be interesting to do a bit of statistical analysis of the experiences of the flow of foreign exchange on the exchange rate and money supply and that of the exchange rate on exports growth. This way it may be seen whether the exporters or RBI have a bigger problem on hand. The last four years or 48 months are considered starting from October 2003 to September 2007, which is further bifurcated into two periods of 34 and 14 months. The first period is up to June 2006 while the second period is from July 2006 onwards when the rupee started appreciating continuously against the dollar. The matrix of results is provided in the Table below.

To avoid the use of statistical jargon, the results have been provided in simple language. The overall strength of the relationship between the variables called ‘coefficient of determination’ is denoted by high, medium and low. The direction of impact as well as the significance of the impact of the primary variable is also captured as is the impact of the ‘other variables’ which are not specified. Hence, if exports are affected by say world demand, then it comes under ‘other variables’.

Quite clearly the two periods show contrasting pictures. Firstly, the period up to June 2006 shows that the exchange rate movements are not really driven by forex inflows. This can be rationalized on grounds of RBI intervention which has ensured that the market oriented rate was not reached. Further, while the direction sounds okay, i.e. more forex inflows cause an appreciation (appreciation goes with a negative sign as we are paying fewer rupees for a dollar), it is not statistically significant. Secondly for money supply there is a strong explanation and the impact too is significant. The third observation is that there are contrary images seen when exports are juxtaposed with exchange rate movements. Exchange rates don’t explain exports much as there are evidently other factors which drive them such as demand factors, price movements, status of units (whether SEZ or not), ability to take a hit on profits etc.

The post June 2006 period is the one where the appreciation took place in a continuous manner. Statistically, a small sample is not ideal, but notwithstanding this limitation, we get a different set of results. All the three relationships hold: forex inflows affect exchange rates and money supply; and exports are explained partly by the exchange rate movements. The impact appears to be in the right direction for all the three relationships, including the one for appreciation and rising exports.

Some interesting points that emerge from the data are that the RBI has bigger problems on hand with rising forex inflows than the exporters. Exports so far have not really been affected by the rupee appreciation even when lags of up to 4 months are considered. In fact, the relationship is still not strong and the explanatory power is not significant. However, the direction is still negative meaning thereby that a lower value of the rupee (appreciation) is associated with rising exports. As a corollary, the conclusion would be that the RBI should concentrate more on tackling the monetization part of the dollars rather than stem the appreciation.