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If we look at the rising rupee as an export burden, it
is a problem. If we look at it as a source of cheap
imports, it is an opportunity, says P. V. INDIRESAN.
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The rupee is increasing in value. Are we happy?
There is a story of two boys. Fond parents of one of
them left a plate of sweets while the boy was
sleeping. When the boy got up, instead of being happy
for the sweets, he was furious: He wanted to know why
he was not included in the party. In the second case,
as a prank, the boy�s friends messed up his room with
horse dung, again while he was sleeping. When he woke
up, instead of getting angry about the mess, he
shouted with joy: There has been a pony in my room!
Where is it?
This story contrasts two mind sets: One that sees
problem in every opportunity and the other, which sees
hope in every affliction. Currently, the rupee is
increasing in value. It is increasing because
foreigners are viewing India as the land of hope. Are
we happy? Apparently not; we are looking at the flood
of foreign exchange as a burden, as a menace.
Two scenarios
As a source of inflation, foreign exchange inflow is a
problem. As a source of capital, the same inflow is an
opportunity. Similarly, if we look at the rising rupee
as an export burden, it is a problem. If we look at it
as a source of cheap imports, it is an opportunity.
Combining both, we can look at the situation either as
a double jeopardy or as opportunity to kill two birds
with one stone. It is all in the mind.
Consider two scenarios: Foreign exchange inflows are
picked up by real-estate speculators who push up
housing prices. To meet that inflation, wages have to
be increased, leading to a spiral of inflation. In the
second scenario, the foreign exchange is absorbed by
innovating industry to develop better technology. As a
result, exports increase in value, leading to a spiral
of cumulative growth.
In the first case, speculators use foreign exchange to
sell goods at inflated prices and profit at the
expense of the consumer. In the latter case,
innovators use the same foreign exchange to improve
productivity; increase their profits by selling better
goods. Speculators play a zero-sum, win-lose game;
innovators play a positive-sum, win-win game.
Indian tourists � third category
Foreign exchange consumers, such as Indian tourists
abroad, are a third category. There was a time when
Indian tourists used to buy everything on sight.
Fortunately, manufacturers have improved so much that
Indian tourists no longer indulge in binge buying the
way they used to. Credit for this noticeable change in
the behaviour of Indian tourists should go to our
manufacturers who may not be great innovators but are
good modernisers. In this respect, modernisers play a
defensive game: they cut wasteful use of foreign
exchange.
Smugglers are a category of consumers who drain the
country�s foreign exchange and salt it abroad with
little benefit either to themselves or to the country.
During the days when Indian taxation was
expropriatory, we used to have lots of them. Even now,
Indians are said to have billions of dollars worth of
foreign deposits secreted abroad. They score goals
against their own country.
Trade balance
We can look at the picture from another angle. At the
time of Independence, the US dollar was worth Rs 4.76;
now, it is eight-nine times costlier. There are two
reasons for the decline of rupee value: One,
productivity of tradable goods has declined compared
to that in the US. (The productivity of non-tradable
goods is immaterial.) Two, the US has brought to the
market many innovative products for which it is able
to charge monopoly prices. For instance, the prices US
manufacturers charge for computers and life-saving
drugs have little relation to manufacturing costs.
The converse also is true: If the rupee appreciates,
the shock can be absorbed either by increasing the
productivity of our tradables or by exporting
high-margin products through innovation.
Unfortunately, our new billionaires are mainly
real-estate developers; there is not one Bill Gates
among them.
Thus, trade balance depends on four kinds of players.
Innovators and modernisers play positively;
speculators and smugglers play negatively. Consumers
are mostly neutral. Wise macroeconomic policy should
discriminate: encourage innovators and modernisers;
discourage speculators and smugglers (and leave
ordinary consumers alone). Unfortunately,
macroeconomic tools (interest rate manipulation, for
instance) treat the economy as a monolith. Like rain,
which falls both on the saintly and on the sinners,
macroeconomic tools make no distinction between good
players and bad ones.
Reward and penalise
Ideally, macroeconomic policy should reward those who
create less than average inflation pressure and
penalise those who contribute to inflation more than
the average. Unfortunately, it is not easy to decide
how much of price increase is reward for product
improvements and how much of it is due to poor
management. Hence, rewards and penalties based on sale
prices lead to interminable disputes, enriching tax
lawyers more than the economy.
On the other hand, a company that increases wage rates
(not wage bills) faster than the national average
generates demand-pull inflation. A company whose
profit rates (not profits) are increasing faster than
the national average contributes to cost-push
inflation. Both kinds of businesses can be identified;
both deserve to be penalised.
However, firms in emerging areas (IT, biotech, for
instance) will claim that they have no option but to
go on raising wage rates because of the nature of
skills required. That is not correct: Salaries in the
IT industry are going through the roof not because
their workers are skilled but because there is a
shortage of talent. If our education system had
produced enough (employable) IT specialists, there
would have been no wage inflation in the IT industry.
IT industries have been crying hoarse that applicants
are many but employable ones are few. Therefore, it is
in trouble not because the rupee value is rising but
because our education providers are doing a shoddy
job.
Insufficient and/or inappropriate education is the
ultimate cause of wage inflation. Hence, better
governance is what we need; clever economics is no
substitute for good governance.
The real challenge
After much hesitation, as traditional Economics
dictates, the government has cut interest rates.
Hesitation, because nobody can predict reliably in
which direction, and to what extent, the economy will
turn when interest rates are cut. Prediction is
difficult because, as explained earlier, macroeconomic
tools do not discriminate between bad players and good
players.
Interest rate management is like aspirin; it is a pain
killer, a palliative. Pain persists when too little
aspirin is taken. If too much is consumed, side
effects, such as internal bleeding, make matters
worse. Similarly, if the cut in interest rates is too
small, economic pain remains. If the cut is too large,
the economy bleeds. Interest rate cuts do not cure but
only provide a breathing space for the economy to
correct itself.
Rupee value is likely to continue to increase for many
more years to come; it is going to be chronic problem.
As interest rate cut is a short-term palliative, it
cannot be the cure for a chronic problem: How long can
we go on decreasing interest rates? Further, the cut
deters not merely hot money but genuine investors too.
How to ensure better governance that increases the
productivity of labour (and of capital) is the real
challenge, not how far interest rate should be cut.
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