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Cushioning effect of forex surge

The impact of sharp appreciation of the rupee since November last year on different segments of the economy is being carefully assessed in industry, forex and money market circles with a view to determining whether the hardening Indian currency is the result of stronger fundamental factors. There is also a desire to know if there has been a technical strengthening with a surge in forex reserves.

However, an analysis of rupee movements against other major currencies reveals that there has been only a modest appreciation against the British pound and the euro. The Japanese yen has of course firmed up against the rupee like the Chinese yuan. The weakening of the dollar against other major currencies has thus been mainly responsible for the significant improvement in the external parity of the Indian currency vis-À-vis the green back.

The rise is noticeable particularly after April this year because, out of the total improvement of 12.21 per cent, the rise in April-October was 9.03 per cent.

As nearly 50 per cent of Indian exports are denominated in dollars, industries relying on rupee proceeds and receiving their export earnings in U.S. currency are badly hit, especially where reasonable profitability is dependent on rupee earnings. Since nearly 40 per cent of the country’s exports comes from textiles, leather and leather products, certain types of chemicals, handicrafts, auto components and products, representations have been made to the Union Commerce Ministry for suitable relief.

The Finance Ministry has been quick to respond with a reduction in duties to the extent of Rs.1,400 crore and there are proposals for further relief. However, the industry circles concerned wonder how adjustment to the new situation can be attempted with a rigid cost structure. It is, of course, being examined how the competitive ability of large, medium and small industries can be improved and export growth sustained around 20 per cent. This aspect of the problem has assumed importance, as it is expected in knowledgeable quarters that the rupee may harden further by 5 per cent in a short period if forex inflows continue the recent trend. Up to October 19 this year, foreign currency assets have risen by a whopping $56.95 billion against $37.21 billion in the whole of 2006-07.

Even with a dearer rupee, growth in exports so far this year at 18.5 per cent has not been disturbingly low when compared to the 27 per cent a year ago. Imports are being received at a faster rate than in 2006-07, the growth in the period under reference being 31.2 per cent (20.5 per cent).

With world crude prices at unbelievably high levels, the trade gap may widen uncomfortably in the coming months.

Non-oil imports also are being received in larger volume. The trade deficit may thus be $80 billion against $54 billion. The gap according to a Reserve Bank of India computation may be even larger. But the trade gap for 2006-07, according to RBI, was not reflected in a bigger current account deficit as net invisible receipts were also higher. The actual deficit increased only marginally to $9.60 billion from $9.18 billion.

In April-June this year also, the current account deficit could be maintained at the same level ($4.67 billion against $4.6 billion) in spite of a larger trade deficit of $21.53 billion against $16.94 billion. Net invisible receipts on the other hand were higher at $16.88 billion against $12.37 billion. The deficit would have been more worrisome but for the fact there was a narrowing of the difference between the figures of the RBI and the Directorate General of Commercial Intelligence and Statistics. The bridging of even a larger gap will not be difficult because of surging inflows on capital account.

Meanwhile, the monetary authorities are worried about steps to moderate further appreciation of the rupee by effecting purchases of dollars. While the prospects of a further growth in foreign currency assets are being examined following the clearing of the confusion created by the decision of the Securities Exchange Board of India to regulate the use of participatory notes by foreign institutional investors the situation in the money market has eased significantly.

The fairly regular intervention by the RBI for some time now has led to a sharp rise in resources of banks and financial institutions. In contrast to the earlier fears of stringency in the money market, the money market is quite comfortable, thanks to a surge in deposits of banks and resources of financial institutions and a slowdown in the growth of bank credit.

The glut in the money market is likely to persist in the coming months with the continuing rise in foreign exchange assets in the absence of unfavourable developments and no noticeable growth in advances of banks. If the monetary authorities feel obliged to minimise the excess liquidity in the banking system it may be necessary to hike again the cash reserve ratio by 0.5 percentage point initially and another 0.5 per cent after 2 or 3 months if available resources do not get utilised purposefully.

P. A. SESHAN

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