Indian exports enjoyed the advantage of slow depreciation of currency during the period of mid-2005 to mid-2006. Rupee showed a turn around since August 2006. In terms of Real Effective Exchange Rate (REER), it rose steadily between August to November 2006 and slipped slightly thereafter. From March 2007 onwards, Rupee experienced a rise in its value. As per REER (Graph 3.1), rupee has appreciated by almost 8% during March to May 2007. Appreciation was much higher against US Dollar compared to Euro. Another round of appreciation is visible between August-October 2007, which has been relatively mild. REER provides the trade weighted average change in exchange rate vis-à-vis major currencies. Hence, the appreciation rate as reflected in REER provides a combined pictureof how Indian Rupee got appreciated in recent times.

Rupee got depreciated during July to October 2005 and then February to August 2006. In Rupee terms, monthly exports grew by 51% and in US Dollar terms monthly exports growth rate was 41% during this period July to October 2005. In the entire period of 2005-06, exports grew by 23.44% in US Dollar terms and touched US $ 103 billion. In terms of Rupee, growth was around 21.6% and total exports in 2005-06 were Rs.4.6 trillion. During the period 2006-07, India’s exports grew almost by 22.5% in US Dollar terms and total exports reached to US$ 126 billion. In Rupee terms, growth was 25.3% and total exports were Rs.5.7 trillion. Impact of changing values

of currency on exports has not been significant during 2005-06 and 2006-07 as both the periods were marked by appreciation as well as depreciation of currency which played an overall neutralizing role. Moreover, impact of appreciation of Rupee on exports requires at least four to six months time to get realized.

Since April 2007, as there has been sharp rise in the value of Rupee, there is a severe impact on the export growth rate (Table 3.1). The cumulative exports during the period April-October in 2005 was US $ 57 billion (Rs. 2.5 trillion) which increased to US $ 71 billion and (Rs.3.2 trillion) in April-October of 2006 registering a growth rate of almost 24.4% in US Dollar terms (30% in Rupee terms). The cumulative exports during April-October of 2007 have been US $ 85.5 billion (Rs.3.5 trillion). In US Dollar term the growth was around 21% but in Rupee terms the growth declined to only 7% implying a serious blow in terms of rupee realization of Indian exports.

In case of imports, cumulative value of imports for the period April-October, 2007 was US $ 130 billion (Rs. 5.3 trillion) as against US$ 103.7 billion (Rs. 4.8 trillion) registering a growth of 25.31% in Dollar terms and 11.07% in Rupee terms during the same period of 2006. The import growth rate for the same period in 2006 over 2005 was 26% in US Dollar terms and 32% in Rupee terms. Slowing down of import growth in 2007 has been mainly because of less growth in POL import. This has proved that India’s import has not increased significantly despite the fact that Indian rupee has appreciated significantly in recent months. In fact, slowing down of import growth rate implies that India’s import is less elastic with respect to exchange rate.

Currency Appreciation and Export Value: Recent Experience

In 2006-07, India witnessed large trade deficits to the tune of US $ 65 billion and current account deficit was as high as US $ 10 billion. The level of trade deficit should have been enough to depreciate the rupee, as supposed in traditional exchange rate theories. However, interest rate cuts by the US Federal Reserve led to higher inflow of portfolio investments into the country resulting in unprecedented and continuous rupee appreciation. Foreign portfolio investment recorded an inflow of US $ 20.7 billion during April-July 2007. FDI inflow was also significantly high and recorded US $ 6.6 billion during April-July 2007 (US $ 3.7 billion in April-July 2006). Large inflow reflects expansion of domestic activities, positive investment climate, and positive view towards India as a long-term investment destination. All these have raised an upward pressure on Indian Rupee (INR).

Table 3.1

India’s Exports vsi-a-vis Exchange Rates

Source: Calculated from India Trades, CMIE

Rupee depreciated steadily for a decade after being floated in 1993, dropping from an average annual rate of Rs. 31.37 per US Dollar in the 1993-94 fiscal year (April-March) to Rs. 48.40 per US Dollar in 2002-03 (an average annual depreciation of nearly 5%). From 2003-04 to 2005-06, however, the rupee appreciated against the US Dollar by 3% on average a year. But the rate of appreciation of Indian Rupee has been unprecedentedly high from July 2006 till date, falling by about 16.3 % (46.97 to 39.25 per US Dollar). The average rupee-US dollar rate in November 2007 was the lowest since 1999-2000.

On the other hand, though the Indian Rupee appreciated against Euro, Pound Sterling and Yen also, the rate of appreciation has been much lower. Moreover, the upward rallying of rupee against these currencies more or less leveled off since May 2007, though there have been high fluctuations in weekly movements. Against Euro, Indian Rupee shows a slight but steady depreciation from July onwards. The trend of exchange rate vis-à-vis US Dollar and Euro is given in Table 3.2 and Graph 3.2 and 3.3 below.

Table 3.2
India’s Exchange Rate

Source: Reserve Bank of India

Graph 3.2

Source: Monthly exchange rate available in India Trades, CMIE and RBI

Source: Monthly exchange rate available in India Trades, CMIE and RBI

The current upward rallying of Rupee evidently is a natural outcome of India’s robust economic growth over the last decade. With low interest rates in US, India and other emerging markets are becoming increasingly attractive as an investment destination for US and other countries. As more and more Dollar flows to India, its supply exceeds demand and result in depreciation against Indian Rupee. As most of India’s trade is through US Dollar, continuous appreciation of Indian Rupee against US Dollar has a significant impact on exports. Exports through Euro were unable to balance the loss incurred in exports earning through US Dollar.

Graph 3.4 below explains the dynamics of India’s export growth. Export values in terms both Rupees and US Dollar are described in the diagram. Rupee values are measured on the left hand vertical axis and values in US Dollar in right hand axis. The average monthly growth (calculated through CAGR) of exports during April-September in 2006 was 4.54% in US Dollar (5.08% in Rupee terms). Higher growth in Rupee terms compared to US Dollar implies the advantage of depreciated currency in realization of exports. The monthly average growth rate during the same period of 2005 was 2.07% in US Dollar (2.15% in Rupee). However, during 2007, though exports were growing but decline in growth rate is very much visible. In the period April-September of 2007, Indian exports grew by 3% per month in US Dollar and in terms of Rupee the rate was 2.15%. Lower growth rate in rupee terms compared to US Dollar shows that due to appreciation, the export income in Rupee is slowing down.

The growth of India’s exports in 2006 was both due to fast growth of world exports as well as due to its depreciated currency. In 2006, according to WTO, world export growth was around 8%. Export growth may slow down to 6% in 2007 due to moderate deceleration of World economic growth. Hence, slowing down of Indian exports is also partially due to slow down of world demand in 2007 and not completely due to Rupee appreciation. Also it is important to note many other currencies have shown the tendency of appreciation (Graph 3.5) and as a result competitive disadvantage of Indian exports due to appreciated currency have also partially

neutralized. Some of these countries have given extra thrust in increasing productivity and perhaps India is loosing its advantage due to that. The rise in world merchandise exports in 2006 was also due to global inflation. Almost 40% of exports value was due to this price effect. As the world inflation slows down, the extent of price effect will also come down in the export market. This might have contributed to slow down of India’s export growth also.

Graph 3.5
Dollar changes vis-à-vis selected major currencies, 2001-2006
(Indices, January 2001=100)

a. Trade weighted currency basket of the Korean won, the Singapore dollar and Chinese Taipei dollar.
Source : http ://www.wto.org/english/news_e/pres07_e/pr472_e.htm

Effect on Labour Intensive Exports

Rupee appreciation affects different sectors, differently. High-import intensity sectors like automobiles, petroleum products, gems and jewellery, fare better in face of a stronger rupee as appreciation renders their imported inputs to a lower value. However, the appreciating rupee could significantly erode net profit margin of low-import intensity sectors like textiles and leather, as exporters of these sectors remain in a disadvantageous position especially in price sensitive international markets. Many of the low-import intensity sectors also operate with very low margins, making them feel the heat of rupee appreciation more. The impact on employment is also directly related to the factor intensity of production both in the export units as well as in the input sector. An analysis of this is given in Table 3.3.

If the input sector is labour intensive and export units use largely imported inputs, employment in input sector will get the hit as they will be replaced by cheap foreign inputs. This implies that even though high import-intensity sectors benefit from the appreciating rupee it does not necessarily mean that in the longer run the economy, as a whole, will be benefited.

Continued rupee appreciation could have a long lasting impact on employment as most low import-intensity sectors are highly labour-intensive and they lay off labour quickly as rupee appreciation erodes their profitability. Also

Table 3.3

Impact of Rupee Appreciation on Exports and Employment

employment in import-competing industries may get hit later on. Job losses were already reported in certain sectors, such as textiles and leather. The strain on the labour market became visible ever since last year when number of registered job seekers in the country shot up by more than 2 million to 41 million. Significantly, the increase came after two consecutive years of decline in registered work applicants.

The software exports sector also gets affected by the long-march of rupee. Indian IT companies derive a large share of their revenues from the US and a strengthening rupee erodes their margins. Software industry body NASSCOM contends that there has been ‘too much rupee appreciation in too short a time’, making small and medium IT companies to be the hardest hit. Industry sources state that a one per cent rise in the rupee value would affect bottom-line of the IT and BPO sectors by 30 to 40 basis points.

While the full impact of the negative growth on employment will be assessed by the end of the financial year, the reports from industry and trade associations and exporters indicate that if this trend continues, by March 2008, the total job losses may exceed 2 million.

A limited survey conducted by the Regional Authorities under DGFT covering 83 units including leather, textiles, engineering, plastics, marine products, pharmaceuticals, chemicals, agriculture and food processing, electronics and handicrafts and carpets has shown a job loss of 20,769 between April-November 2007.

Impact on Textile Sector

Textile is an important sector in India’s export basket. This sector has negligible use of imported inputs and is employer of large number of people in India. Rupee appreciation has indicated loss in export growth both in textile as well as in readymade garment (RMG) sector. Graph 3.6 and 3.7 provides trend picture of exports from this two sectors. A comparison between April-June in 2006 and 2007 reveals that textile sector exports dropped by 0.66% in terms US Dollar (by 10.13% in rupee terms). The decline in RMG exports has been more severe. The exports fell by 4.21% in US Dollar terms and by 13.19% in Rupee terms.

Graph 3.6

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

At product level, steep decline is observed in case of cotton apparels which have share of 80% in total apparel exports. In case of woven category, decline in exports are also observed. RMG exports fell by more than 10% in USA market which comprises of 31% of the market and by only 4% in EU market having share of 45% of total RMG exports. Clothing sector is highly labour intensive. An investment of Rs.100 million generates 500 direct and 200 indirect jobs. Around 5.8 million people are engaged in apparel industry. Due to slowing down of the export growth, employment generation will be mere 12% of what has been targeted. In fact in many sub categories, job losses are already reported. It is estimated that for every percentage point of appreciation, profitability of exports in textile sector is hit by 1.2%.

Impact on Leather Sector

Graph 3.8 below shows that leather exports have fallen mainly at the beginning of the year, which may be due to early appreciation during the October to January period. During April-September, exports have increased. However, in rupee terms export grew only by 4.84% (in US Dollar terms by 16%) implying erosion at the time of realization of exports in Rupee.

Over 65% of leather exports are invoiced in US Dollar. The problem is compounded as most of the Indian exporters cater to the lower end of the global market where penetration is directly depended on the price lines offered by the exporters. Moreover, several American Brands operating in Europe prefers to trade with US Dollar than Euro and hence leather exporters are unable to switch to euro to shield their losses. The manufacturing units in the leather sector are more or less compartmentalized as one serving the global markets and the other domestic markets. In view of this arrangement, exporters have no set up or experience to sell their products in the domestic markets. Thus, when the rupee appreciated almost to 12% in a shorter time exporters had no other alternative but to start reducing their production and think in terms of lay off of the employees.

Graph 3.7

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Graph 3.8

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Leather exports are significantly dependant on orders from the foreign buyers. Accordingly most of the employment offered by the sector is either unorganized or in form of contract employment. Due to the current Rupee appreciation, exporters are unable to negotiate prices with big buyers which resulted into smaller orders and this in-turn has caused loss of employment to the people working on contract basis or in unorganized sector. More than 94% of the manufacturing units serving the export markets are either small or medium sized ones. These units operate on thin margins and depend heavily on own funds for working capital as access to institutional finance is cumbersome or need collaterals. When the export realization has reduced, it not only wiped out the margins but also reduced the working capital. This led most of the exporters in to a vicious cycle of debt-low productivity.

Impact on Gems and Jewellery

The sector is highly labour intensive but at the same time import intensity is equally high. Exports in this sector have produced spikes with upward trend since mid 2006. There was big drop in exports in November 2006, February and April 2007. Details of this are described in Graph 3.9 below. The sector has experienced a rising export trend during the period April-June 2007. Comparing the same period in 2006, exports in 2007 has grown by 27% in US Dollar terms and 15% in terms of Rupee. However, exports in Rupee having relatively slower growth imply that sector is not immune from the rupee appreciation despite having high import intensity. This is mainly due to the fact that exporters were unable to neutralize risk considering a forward contract. As rupee has appreciated after the contract has been signed, exporters lost in terms of actual value received. The industry is significantly driven by SME players who operate on a thin margin of 3-6%. Loss in realization of export values while converting into rupee has eroded their margin significantly. The industry requires large working capital in view stocking of important raw materials and finished goods. Erosion of export earnings has also created a strain in terms of availability of working capital.

Graph 3.9

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Impact on Handicrafts Sector (Excluding Handmade Carpets)

Handicrafts are highly labour intensive products but pricing of handicrafts are difficult to explain by market forces completely. The intrinsic values of handicrafts are such that price depends on many non-market issues. The export market of handicrafts products is a reflection of this. Graph 3.10 below explains the fluctuating trend of Indian handicrafts exports. It dropped significantly in July 2006 and rose again in September and fell thereafter. The cumulative exports during April-June 2006 were around US $ 110 million (Rs.5017 million) and it dropped to mere US $ 64 million (Rs.2610 million) during April-June 2007 reflecting a major erosion of export income both in terms of Indian Rupee and US Dollar. It is also important to mention that due to the time gap between contract, delivery and payment, exporters are bound to have been affected as Rupee appreciated so sharply within such a short time. As large numbers of rural and poor artisans are dependant on handicrafts products and most of the time they do not have fixed wages and they sell their products at piece-rate, any short fall in the export market affects them severely.

Graph 3.10

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Other sectors such as engineering goods, forest products, sports goods, chemical products agro products such as tea, rubber, coffee, etc. are also affected by rupee appreciation but the degree of injury is varying.

Other Contributory Factor to the Slowdown in Export Growth

Infrastructure bottlenecks acts as additional contributory factor to the slowdown in export growth. The high power costs and the erratic and inadequate supply of electronic power have adversely affected the competitiveness of Indian exporters especially of small and medium enterprises. The Indian ports take a turn round time of 3-5 days as against only 4-6 hours at other international ports like Singapore and Hong Kong. As far as internal transport is concerned, the secondary roads and inter-state checkpoints are still needed to be improved further. Time taken for transportation of goods from the production centres to the port of export is an important factor in determining the cost of transaction. Due to various provisions governing inter-State movement, lot of time is wasted at the intra-State and inter-State checkpoints/ borders while good are moved through road transportation. With the growth of trade and increase in number of consignments, there is a need not only for improved trade infrastructure facilities to international standards but also for streamlining trade data infrastructure to remove any data anomalies and provide the basis for appropriate policy formulation.

Full neutralization of taxes needs to be ensured so that Indian exports do not become uncompetitive in the international market. The present system of neutralization of taxes through the Duty Drawback and Duty Entitlement Passbook Scheme do not take care of neutralization on account of State taxes like octroi, mandi tax, electricity tax, etc. which is another contributing factor to the slowdown in export growth. While re-imbursement of inputs services used in manufacture of export products is possible through CEVAT route, there is no mechanism for reimbursement of post-production export-related activities/ services obtained like service tax paid to foreign countries, inland haulage charges, commission paid to agents etc. thus adversely affecting the competitiveness of Indian exports. The small manufacturers who are either in non-excisable sectors or are exempted from purview of excise duty have to bear incidence of service tax paid during course of exports. This makes their products unproductive. Though there is a provision of refund under the VAT Act, which came into effect from 1st April 2005, the refund mechanism is yet to be operationalised in most of the States and exporters are facing problems on this account.

Government Initiative and Strategy Options

Dr. C. Rangarajan, Chairman of the Economic Advisory Council to the Prime Minister has been requested by the Prime Minister’s Office to look into and offer suggestions on the measures sought by the Department of Commerce for mitigating the adverse effect on the exports arising out of the appreciation of the rupee. The National Manufacturing Competitiveness Council (NMCC), headed by the Dr. V. Krishnamurthy has been directed by the Prime Minister’s Office to further examine the measures and make appropriate recommendations to the competent authority for necessary implementation.

As India’s exports are getting affected, government of India has also taken several steps to neutralize the effect of rupee appreciation. Government announced a package in July 2007 which is mainly in the form of providing several incentives to exporters and enhancing some of the existing ones. The package includes enhancing of DEPB rates, duty drawback rates, decrease of ECGC premium, pre and post shipment credit interest rate, etc. To clear all arrears of terminal excise duties and CST reimbursement, an amount of around Rs.6000 million has been released by the Ministry. The government has also announced the exemption of Service Tax paid on post production export of goods. The exemption is allowed on some taxable services, which are not in the nature of “input services” but could be linked to export goods. However, some exporters are of the opinion that this incentive may be extended to service tax paid by exporters to foreign agents, movement of goods from factory to port/ICDs, on bank charges etc.

Apart from this, RBI has also announced to provide interest subvention of 2 percentage points per annum to all scheduled commercial banks in respect of rupee export credit to the specified categories of exporters mainly which have labour intensive production technique and less import intensity in terms of input use.

Several organizations have also provided suggestion to government and currently they are being studied. Some of the suggestions are as follows:

• Funds in EEFC account may have the interest rates at par FCNR
• Separate refund mechanism for state level taxes
• Introduction of EXIM Scrips
• Separate export working capital fund which will be available to Bank at a cheaper rate etc.

RBI also has taken up several monetary policy measures which have some impact on the system especially on the value of Rupee. On July 31 2007, RBI raised the cash reserve ratio by 50 basis points, to 7% in order to drain liquidity from the system and thereby to handle inflation. At the same time it lowered the amount of money raised from external commercial borrowing that can be converted into rupees. It is expected that this will reduce the capital inflow and dampen the pace of Rupee appreciation. Central Banks of other countries where domestic currencies have been appreciating also take similar steps. The whole range of instruments include direct sterilisation through issuance of government or central bank bonds, increases in reserve requirements, and different means of capital account management to manage the monetary impact of excess forex flows.

Firms are also required to handle their foreign exchange with due care. As India is gradually getting integrated with the world economy, currency volatility will become a normal affair. It is important to mention that firms are enjoying several incentives for quite sometime but there is a big question about converting these incentives into productivity gain. Loss due to currency appreciation may partly be neutralized with lower cost of production emerging from higher productivity. Within industry also, the effect of rupee appreciation varies among firms. More productive firms can absorb the loss in a better way. Also, due to volatile currency market, firms need to learn sophisticated methods of risk management.

Short term strategies of firms will be to use forex derivatives like forward contracts, options swaps and futures. Use of derivatives ensures the profit margins for cash inflows or outflows of foreign currency business transactions. Forwards are very useful for exporters especially in case of US Dollar has premium for forward values and is depreciating against Rupee. Exporters may use forward contract to switch the invoice currency into strong currencies by paying nominal charges without bothering the foreign buyer to change the invoice currency.

Medium Term strategies mostly cover operational efficiency to hedge currency risk. Such approach covers internal matching of exposures by netting currency assets and liabilities, currency risk sharing clause in sale & contract, structured financial deal to reduce cost of borrowing etc. Analysis of cost portfolio is also essential. In the medium term, firms must start looking into the issues related to value addition of products and not just the cost arbitrage Exporter while considering a market entry, develops promotional strategy taking into account the anticipated exchange rate changes. Appreciation of rupee will adversely effect allocation of funds for such activities as compared to their competitors in international markets. Cost reduction will help to maintain promotional budget for business development.

Long term strategy of firm must focus on protection of foreign market shares, updating the product to reduce price sensitivity, making attempts for brand development and broaden the markets. Companies have to respond to exchange risk by altering their product strategy covering product innovation and new product introduction based on R&D. Constant improvement in product by following creative destruction of old product is required for survival during the time of strong rupee scenario. Quality of the product and service must be of world-class to win trust of overseas buyers. Companies also need to allocate sufficient funds to train employees about nuances of international business environment including risk management.

ANNEXURE

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Source: Calculated from Principal Commodity Exports, India Trades, CMIE

Processed Foods include processed fruits and juices, Processed vegetables Meat & Preparations and miscellaneous processed items
Source: Calculated from Principal Commodity Exports, India Trades, CMIE