Indian exports enjoyed the advantage of slow depreciation of currency during the period of mid

8/7/2019 Indian exports enjoyed the advantage of slow depreciation of currency during the period of mid

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Indian exports enjoyed the advantage of slow depreciation of currency during theperiod 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 visiblebetween August-October 2007, which has been relatively mild. REER provides thetrade weighted average change in exchange rate vis--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 August2006. 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. Inthe 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 totalexports in 2005-06 were Rs.4.6 trillion. During the period 2006-07, Indias exports

grew almost by 22.5% in US Dollar terms and total exports reached to US$ 126billion. 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 asboth 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 asevere 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) whichincreased 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 Rupeeterms). The cumulative exports during April-October of 2007 have been US $ 85.5billion (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 rupeerealization of Indian exports.


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In case of imports, cumulative value of imports for the period April-October, 2007was 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 duringthe 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 Indias import has not increased significantly despite the fact thatIndian rupee has appreciated significantly in recent months. In fact, slowing downof import growth rate implies that Indias 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 andcurrent account deficit was as high as US $ 10 billion. The level of trade deficitshould have been enough to depreciate the rupee, as supposed in traditional

exchange rate theories. However, interest rate cuts by the US Federal Reserve ledto higher inflow of portfolio investments into the country resulting in

unprecedented and continuous rupee appreciation. Foreign portfolio investmentrecorded an inflow of US $ 20.7 billion during April-July 2007. FDI inflow was alsosignificantly high and recorded US $ 6.6 billion during April-July 2007 (US $ 3.7billion in April-July 2006). Large inflow reflects expansion of domestic activities,

positive investment climate, and positive view towards India as a long-terminvestment destination. All these have raised an upward pressure on Indian Rupee

(INR).

Table 3.1

Indias Exports vsi-a-vis Exchange Rates

Indias Exports to World

Average Value Period

(Rs. Million)

(US $ Million)

Rs. Per Euro

Rs. Per US $

Apr-Oct2005 2,494,969 56,928 54.09 43.81

Apr-Oct2006 3,250,912 70,838 58.03 45.86

Apr-Oct2007 3,477,939 85,583 55.73 40.68

Source: Calculated from India Trades, CMIE

Rupee depreciated steadily for a decade after being floated in 1993, dropping froman 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 annualdepreciation of nearly 5%). From 2003-04 to 2005-06, however, the rupeeappreciated 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 tilldate, 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, PoundSterling and Yen also, the rate of appreciation has been much lower. Moreover, the


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upward rallying of rupee against these currencies more or less leveled off sinceMay 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--vis US Dollar and Euro is given in Table3.2 and Graph 3.2 and 3.3 below.

Table 3.2Indias Exchange Rate

Source: Reserve Bank of India

Graph 3.2

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


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

The current upward rallying of Rupee evidently is a natural outcome of Indiasrobust economic growth over the last decade. With low interest rates in US, India

and other emerging markets are becoming increasingly attractive as an investmentdestination for US and other countries. As more and more Dollar flows to India, itssupply exceeds demand and result in depreciation against Indian Rupee. As most

of Indias trade is through US Dollar, continuous appreciation of Indian Rupeeagainst 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 Indias export growth. Export values interms both Rupees and US Dollar are described in the diagram. Rupee values aremeasured 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 rateduring 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 isvery 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%. Lowergrowth rate in rupee terms compared to US Dollar shows that due to appreciation,

the export income in Rupee is slowing down.

The growth of Indias exports in 2006 was both due to fast growth of world exportsas 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 dueto 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 notcompletely 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 resultcompetitive disadvantage of Indian exports due to appreciated currency have also

partially

neutralized. Some of these countries have given extra thrust in increasingproductivity and perhaps India is loosing its advantage due to that. The rise in


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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, theextent of price effect will also come down in the export market. This might have

contributed to slow down of Indias export growth also.

Graph 3.5Dollar changes vis--vis selected major currencies, 2001-2006

(Indices, January 2001=100)

a. Trade weighted currency basket of the Korean won, the Singapore dollar andChinese 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 intensitysectors like automobiles, petroleum products, gems and jewellery, fare better inface of a stronger rupee as appreciation renders their imported inputs to a lower

value. However, the appreciating rupee could significantly erode net profit marginof low-import intensity sectors like textiles and leather, as exporters of these

sectors remain in a disadvantageous position especially in price sensitiveinternational markets. Many of the low-import intensity sectors also operate with

very low margins, making them feel the heat of rupee appreciation more. The


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impact on employment is also directly related to the factor intensity of productionboth 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 benefitfrom 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 asmost 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 werealready reported in certain sectors, such as textiles and leather. The strain on thelabour market became visible ever since last year when number of registered jobseekers 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 workapplicants.

The software exports sector also gets affected by the long-march of rupee. Indian


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of 45% of total RMG exports. Clothing sector is highly labour intensive. Aninvestment of Rs.100 million generates 500 direct and 200 indirect jobs. Around5.8 million people are engaged in apparel industry. Due to slowing down of the

export growth, employment generation will be mere 12% of what has beentargeted. 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 termsexport 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 iscompounded 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 theexporters. Moreover, several American Brands operating in Europe prefers to tradewith 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 orless compartmentalized as one serving the global markets and the other domesticmarkets. In view of this arrangement, exporters have no set up or experience to

sell their products in the domestic markets. Thus, when the rupee appreciatedalmost 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


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Leather exports are significantly dependant on orders from the foreign buyers.Accordingly most of the employment offered by the sector is either unorganized orin form of contract employment. Due to the current Rupee appreciation, exportersare 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 contractbasis or in unorganized sector. More than 94% of the manufacturing units servingthe 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 toinstitutional finance is cumbersome or need collaterals. When the export

realization has reduced, it not only wiped out the margins but also reduced theworking 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 isequally high. Exports in this sector have produced spikes with upward trend sincemid 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 experienceda 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% interms of Rupee. However, exports in Rupee having relatively slower growth implythat sector is not immune from the rupee appreciation despite having high importintensity. This is mainly due to the fact that exporters were unable to neutralizerisk considering a forward contract. As rupee has appreciated after the contract

has been signed, exporters lost in terms of actual value received. The industry issignificantly 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 marginsignificantly. The industry requires large working capital in view stocking of

important raw materials and finished goods. Erosion of export earnings has alsocreated a strain in terms of availability of working capital.

Graph 3.9


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Impact on Handicrafts Sector (Excluding Handmade Carpets)

Handicrafts are highly labour intensive products but pricing of handicrafts aredifficult to explain by market forces completely. The intrinsic values of handicraftsare 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 thefluctuating trend of Indian handicrafts exports. It dropped significantly in July 2006and rose again in September and fell thereafter. The cumulative exports duringApril-June 2006 were around US $ 110 million (Rs.5017 million) and it dropped tomere US $ 64 million (Rs.2610 million) during April-June 2007 reflecting a majorerosion of export income both in terms of Indian Rupee and US Dollar. It is alsoimportant to mention that due to the time gap between contract, delivery andpayment, 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 aredependant on handicrafts products and most of the time they do not have fixedwages and they sell their products at piece-rate, any short fall in the exportmarket affects them severely.

Graph 3.10


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Other sectors such as engineering goods, forest products, sports goods, chemicalproducts agro products such as tea, rubber, coffee, etc. are also affected by rupee

appreciation but the degree of injury is varying.

O ther Contributory Factor to the Slowdown in Export Growth

Infrastructure bottlenecks acts as additional contributory factor to the slowdown inexport growth. The high power costs and the erratic and inadequate supply of

electronic power have adversely affected the competitiveness of Indian exportersespecially 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 likeSingapore and Hong Kong. As far as internal transport is concerned, the secondary

roads and inter-state checkpoints are still needed to be improved further. Timetaken 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 variousprovisions governing inter-State movement, lot of time is wasted at the intra-State

and inter-State checkpoints/ borders while good are moved through roadtransportation. With the growth of trade and increase in number of consignments,there is a need not only for improved trade infrastructure facilities to internationalstandards 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 notbecome uncompetitive in the international market. The present system of

neutralization of taxes through the Duty Drawback and Duty Entitlement PassbookScheme 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 slowdownin export growth. While re-imbursement of inputs services used in manufacture of

export products is possible through CEVAT route, there is no mechanism forreimbursement of post-production export-related activities/ services obtained likeservice tax paid to foreign countries, inland haulage charges, commission paid toagents etc. thus adversely affecting the competitiveness of Indian exports. The

small manufacturers who are either in non-excisable sectors or are exempted frompurview 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 refundmechanism is yet to be operationalised in most of the States and exporters are

facing problems on this account.

Government Initiative and Strategy O ptions

Dr. C. Rangarajan, Chairman of the Economic Advisory Council to the PrimeMinister has been requested by the Prime Ministers Office to look into and offer

suggestions on the measures sought by the Department of Commerce formitigating the adverse effect on the exports arising out of the appreciation of therupee. The National Manufacturing Competitiveness Council (NMCC), headed by

the Dr. V. Krishnamurthy has been directed by the Prime Ministers Office tofurther examine the measures and make appropriate recommendations to the

competent authority for necessary implementation.


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As Indias exports are getting affected, government of India has also taken severalsteps to neutralize the effect of rupee appreciation. Government announced a

package in July 2007 which is mainly in the form of providing several incentives toexporters and enhancing some of the existing ones. The package includes

enhancing of DEPB rates, duty drawback rates, decrease of ECGC premium, preand 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 beenreleased by the Ministry. The government has also announced the exemption of Service Tax paid on post production export of goods. The exemption is allowed onsome 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 thisincentive 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 2percentage 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 inputuse.

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

y

Funds in EEFC account may have the interest rates at par FCNR

y

Separate refund mechanism for state level taxes

y

Introduction of EXIM Scrips

y

Separate export working capital fund which will be available to Bank at acheaper rate etc.

RBI also has taken up several monetary policy measures which have some impacton the system especially on the value of Rupee. On July 31 2007, RBI raised thecash 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 paceof Rupee appreciation. Central Banks of other countries where domestic currencies

have been appreciating also take similar steps. The whole range of instrumentsinclude direct sterilisation through issuance of government or central bank bonds,

increases in reserve requirements, and different means of capital accountmanagement to manage the monetary impact of excess forex flows.

Firms are also required to handle their foreign exchange with due care. As India isgradually getting integrated with the world economy, currency volatility will

become a normal affair. It is important to mention that firms are enjoying severalincentives for quite sometime but there is a big question about converting theseincentives into productivity gain. Loss due to currency appreciation may partly be

neutralized with lower cost of production emerging from higher productivity. Withinindustry 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


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contracts, options swaps and futures. Use of derivatives ensures the profit marginsfor cash inflows or outflows of foreign currency business transactions. Forwards are

very useful for exporters especially in case of US Dollar has premium for forwardvalues and is depreciating against Rupee. Exporters may use forward contract to

switch the invoice currency into strong currencies by paying nominal chargeswithout 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 assetsand liabilities, currency risk sharing clause in sale & contract, structured financialdeal 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 additionof products and not just the cost arbitrage Exporter while considering a market

entry, develops promotional strategy taking into account the anticipated exchangerate changes. Appreciation of rupee will adversely effect allocation of funds forsuch activities as compared to their competitors in international markets. Costreduction 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 branddevelopment and broaden the markets. Companies have to respond to exchange

risk by altering their product strategy covering product innovation and new productintroduction based on R&D. Constant improvement in product by following creativedestruction of old product is required for survival during the time of strong rupeescenario. 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 trainemployees about nuances of international business environment including risk

management.

ANNEXURE



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Processed Foods include processed fruits and juices, Processed vegetables Meat & Preparations and miscellaneous processed items



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