The third wave approach

Written by PK Vasudeva | Updated: Sep 28 2007, 05:15am hrs
The appreciation of the Indian rupee in recent months has caused grave concern to exporters, as they are finding it difficult to compete with countries like China, Korea and even Bangladesh in textiles. Despite statements of the Union commerce & industry ministry, Kamal Nath, exporters have ratcheted up their plea for cuts in bank lending rates. With the US Federal Reserve board announcing a 50-basis-point-cut in benchmark rates and setting off expectations in India of strong FII and FDI flows, the currency has breached the Rs 40 mark, hitting a nine-year high against the dollar. Exporters are in great agony over the impact of a weakening dollar on its earnings, but they should not bet on helpful interventions from the RBI, whose concerns are more basic.

Federation of Indian Export Organisation chief GK Gupta has said the cut in the US Fed rate would contribute to larger inflows from abroad as long as the RBI does not effect matching cuts in domestic interest rates. Hence, the RBI should immediately cut interest rates, which would enable banks to lower their prime lending rate (PLR), providing some relief in export credit to trade and industry.

The increase in PLR by about 2 to 2.5 percentage points has offset the advantage that accrued to exporters by the extension of pre-shipment and post-shipment credit at 4.5% below PLR. The RBI should, therefore, bail out exporters. Order books are perilously lean right now. Arrears of the increased duty entitlement pass book (DEPB) drawback and interest rate benefits on export credit have still not been given to exporters, while service tax relief has only been small relief since many important services have been left uncovered by the refund mechanism.

Luckily, inflation is under control, which may let the central bank calibrate its play in the currency market to keep the dollar from falling too far below the Rs 40 level. Yet, if the RBI defends the dollar, it may unduly increase money supply and stoke inflation. Moreover, modest intervention may not do exporters much good. Note that the equity market now has FIIs returning in full force.

At the same time, exporters must adapt to reality. From a policy viewpoint, this is a good time to convince exporters that any government compensation for drops in earnings on account of the rising exchange rate will be temporary. Two months ago, the textiles ministry put it out that the Prime Minister would be petitioned for relief, including getting the RBI to intervene in the forex market. But at this point, and perhaps for the medium termin fact, so long as capital flows continue to keep the real economy and stock market flush with fundsthe RBI will have to balance the interests of exporters, who want a cheaper rupee, with those of the economy that requires cheaper imports of foodgrains and oil (in short, lower costs all round).

Under the present circumstances, exporters will have to learn to live with a strong rupee and with continuous exchange rate swings. In the 1990s, the rupee was allowed to depreciate hugely against the dollar; with greater financial market integration now, such a slide can be sustained only by closing the foreign investment inlet or by the RBI buying dollars, creating unmanageable levels of liquidity that would prove inflationary and distortive of relative prices. The writing on the wall is clear: exporters must relocate their competitive advantages in what one infotech practitioner calls the Three Wave approach. First wave: exporters must move away from being component suppliers. Second wave: they need to procure goods through contract manufacturing. Third wave: they should market their own brands. In this wave, exporters will have to create services and products that can command premium, value-based prices, thereby mitigating any adverse change in the exchange rate. A rising rupee may actually persuade exporters to build competitive advantage on a long-term basis by riding the three wave approach.

The author is professor of international trade at Icfai Business School, Chandigarh.