Enough evidence to show the value of the rupee makes a big difference, so RBI needs to continue to do its bit
With the central bank coming out with a rebased Real Effective Exchange Rate (REER)—and with an expanded basket of currencies, from 36 countries earlier to 40 now—the focus is once again on whether the rupee is fairly-valued and the impact this has on India’s exports. This time around, RBI has also changed the base year from 2004-05 to 2015-16 since, as it feels, this is a year in which India was in balance, so to speak. An article in the latest RBI Bulletin by two staffers in its department of economic and policy research points out that, in that year, GDP grew by 8%, CPI inflation was a reasonable 4.9%, and the current account deficit was just 1.1% of GDP. While there is some dispute over whether the current account was really in balance due to better export performance or whether this was only due to the collapse of oil prices that year, the short point is that, as RBI staffers say in the paper, the old and new series—both in terms of trade-weightage and export-weightage—move closely in the same direction and, while the rupee appears fairly valued right now, it has appreciated considerably over time. The study talks of an export elasticity of 0.7 to 0.9—that is, a one per cent appreciation of the rupee reduces export growth by 0.7-0.9 per cent—and, more important, says that “going forward, large capital inflows unless fully absorbed through current account deficit and/or mopped up as foreign exchange reserves can cause an appreciation of the rupee and potentially undermine the export competitiveness”. While RBI buying dollars invites the wrath of the US, since India is a current account deficit nation, it cannot really be called a currency manipulator.
Given that, as former chief economic advisor Arvind Subramanian points out, no emerging economy has been able to sustain strong and rapid growth without exports contributing meaningfully, the central bank has to keep buying dollars to ensure the rupee remains fairly valued, more so at a time when, thanks to global liquidity, the flood of dollars is all set to increase. Indeed, as JP Morgan chief India economist Sajjid Chinoy points out, it is not consumption but exports that have driven India’s growth; in the boom years of 2003-08, India’s real export growth averaged 17.8% for five successive years whereas domestic consumption (public and private) averaged just 7.2%, and it is the former that drove investment in the country.
Of course, it is not just the rupee that needs to be correctly valued, other policy measures are also needed. With more of global trade taking place between trading blocks, for instance, India just has to align itself with some of them; RCEP, which India has refused to join, accounts for 30% of global GDP right now, and this will rise to 50% by the end of the decade. Being a part of global value chains is an equally important part of the strategy. And, while the government recognises that manufacturing in India is more expensive than overseas—a study on mobile phone manufacturing put this at 9.4-12.5% versus producing in Vietnam—it is not clear how this is to be compensated. In the past, India had a MEIS scheme that partially compensated for this, but while this scheme—that was found to be violating WTO principles—was withdrawn, the money available for its successor RoDTEP is a fraction of what was spent on MEIS. The government wants to, instead, use the money to spend more money on production-linked-incentive (PLI) schemes such as the one for mobile phones, but while funds for PLI are a good idea, they are restricted to a certain number of sectors only; and as this newspaper pointed out earlier, some of the schemes, such as the one on laptops, are in danger of violating WTO norms as well.