As the rupee continues to remain strong, the debate about the exchange rate is hotting up. Hardly a day passes without the pink and, increasingly, even the white newspapers carrying an article or interview on the subject. The interest is of course natural given the fact that, over the years, an increasingly large percentage of the economic activity in the country is being accounted for by external transactions. The prices of many domestic transactions are also governed by the
exchange rate.
Govindraj Ethiraj expressed surprise in an article in this paper (May 15) as to how exporters were "so unprepared for something basic like currency fluctuation". While I agree with the point made to some extent, the limitations of the argument should also be kept in view.
Firstly, hedging against adverse currency fluctuations has some regulatory restrictions and is, therefore, at best, a short-term solution. In any case, hedging can protect against a further worsening of the present rate, but has no solution to an existing, uneconomic rate. But hedging apart, what else can the average exporter do? All his costs are going up -- power, wages, most commodity prices and so on. One solution is to import raw material rather than purchase it from domestic suppliers.
The attraction of imports over the domestic supplies is of course the result of an overvalued currency and those who support continued appreciation or a free float, should really ponder whether a fast increasing merchandise trade deficit (see World Money, April 30, 2007) is really something in our interest at a time when we need to create a crore-plus jobs every year.
Surely there is something wrong when, despite all our comparative advantages in producing textiles, it is necessary to import them today from China to remain in the garment export business -- China, incidentally, imports cotton to
make them.
The term 'Dutch disease' was first coined to describe overvalued currencies, arising from the high prices of a commodity which a country exports. (At one time, the Netherlands faced the problem after huge offshore natural gas discoveries, and hence the name).
Our problem arises not from a surplus on current account, but capital inflows, and is perhaps more comparable to Mexico and east Asia in the mid-'90s, and not to the Dutch disease: overvalued currencies sustained on capital inflows, increasing current deficits, until one day, the music stops.
Some economists, of course, question whether the rupee is at all overvalued; question the accuracy of REER as a measure of competitiveness given its base year, composition, and changes in the economy --
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