In a recent Federation of Indian Chambers of Commerce & Industry study, exporters ranked the appreciation of the rupee against the dollar as their primary concern, followed by the rising cost of raw materials, competition and cost of credit. Their concern is understandable: the rupee has already appreciated by about 10% since April 2007. Now, let us imagine the situation of an exporter who ships at a 5-10% margin. For him, the business is no longer profitable. Small exporters who do not possess sophisticated risk management tools find themselves at sea against such a steep and rapid movement in the value of the domestic currency.
Let us first examine the factors that have influenced the sharp appreciation in the rupee in this cycle and then the alternative strategies that may be deployed to counter this onslaught. As we know, a strong currency has the adverse effect of making exports less competitive in international markets. The flip side, of course, is that this is a boon for importers?though this, in turn, affects the competitive edge of domestic manufacturers.
The Indian economy has been growing at around 9% for the last few years, driven by improved domestic demand. Infrastructure spending, favourable demographics, lifestyle changes and higher disposable incomes have been the key engine for this robust growth. A race toward attractive investment destinations by foreign institutional investors fuelled by easy global liquidity has resulted in an unprecedented rush of dollars to India, where foreign exchange reserves now stand at $251 billion, an increase of $51 billion, or 25%, since April this year.
While the concerned authorities have made an admirable effort to moderate the impact of such a sharp movement in the rupee?s value, the issue remains that, ironically, inflows are currently driven by India?s improved fundamentals. In such an environment, what alternative options are available to the affected stakeholders?
To start with, the rupee has appreciated most against the dollar, which in turn, has depreciated sharply against most other major global currencies. In simple words, it means that the rupee has not appreciated by the same magnitude against currencies like the euro or the yen. Therefore, diversifying exports to other major global markets will mitigate the impact on our international trade.
Secondly, a recent trend has been that of Indian companies acquiring overseas corporations. This provides a natural hedge by diversifying manufacturing bases. This combines not only the advantage of cheap resources like raw material and labour, but also provides a hedge by diversifying the revenue currency basket.
The advance booking of export dollars is another possible solution. With an increasing number of Indian banks providing exchange management solutions, exporters may have a systematic risk management programme at hand. Finally, though currently an ambitious thought, industries where India has a strong competitive advantage, pricing contracts could be drawn up in rupees. Until the rupee travels further down the road of full convertibility, while the invoicing would still be in dollars, costing and pricing could be calculated on the basis of the domestic currency. The derivatives market has a fairly standardised way of doing this, and such cross-currency derivatives are known as quantos.
The current situation is somewhat similar to the first stage of economic liberalisation and deregulation in the 1990s, where after the initial hiccups, Indian companies emerged stronger than ever after a rationalisation process. Elsewhere, like in Japan, companies like Toyota now are world leaders in automobile manufacturing, having initially suffered when the yen started appreciating against the greenback. There is little doubt that the Indian economy will come out far stronger in due course as exemplified by developed economies like Japan.
?The writer is CIO-fixed income & structured products, ABN-Amro