Is the strengthening rupee, a boon or a bane? Well, actually both. It depends from case to case whether the appreciation of the rupee is an advantage or a disadvantage.
Just to give a small example, while the appreciation in the rupee is a positive for the energy sector, it is a cause for worry for the domestic software sector. However, there are few more points that go for and against the rising rupee and this is what this article looks at in brief.
The rupee has appreciated almost 7.3 per cent in fiscal year 2003-04. Of this, about 3.4 per cent appreciation has come about in the first three months of the calendar year 2004 alone. Further, since its lows during May 2002, the rupee has been largely on a one-way street and has gained over 10 per cent since then.
However, much of the appreciation has come about in just the last 12 months or so and this could be attributed to the continuous inflow of US dollars into the Indian markets, either by the foreign institutional investor route, remittances or the foreign direct investment route, which has consistently added to India's forex reserves that stand at close to $110 billion.
In 2004, initial public offerings have played an important role in attracting the foreign money, as the government raised close to Rs 150 billion in the current fiscal.
Further, it seems that FII inflows are likely to continue in the near future for a slew of reasons that include the fast growing Indian economy, relatively attractive interest rates, major IPOs (of the likes of ICICI Bank, TCS, NTPC) currently in the pipeline and the export boom being witnessed in the country.
So, in short, while those happy with the current currency appreciation may enjoy the same for some more time, the pressure on others (who are getting affected due to this phenomenon), might continue for a similar period.
So, who are the ones being affected by the rising rupee?
First let us look at the positives that follow a rising rupee:
Benefit for importers: A rising rupee helps importers to buy goods and services at a cheaper rate than earlier. This is vital for a developing economy that relies heavily on imports. While exports have picked up strongly in the last two years so have imports and this is a good indication for the Indian economy as higher imports normally mean increased economic activity.
Foreign debt service: Appreciation of the rupee helps in easing the pressure, related to foreign debt servicing (interest payments on debt raised in foreign currency), on India and Indian companies.
With Indian companies taking advantage of the United States soft interest rate regime and raising foreign currency loans, known as external commercial borrowings, this is a welcome phenomenon from the point of view of their interest commitments on the loans raised. This will help them avoid taking a bigger hit on their bottomline, which is beneficial for its shareholders.
Outbound tourists/student bonanza: The appreciating rupee is a big positive for tourists traveling or wanting to travel abroad. Considering that the rupee has appreciated by over 10 per cent against the US dollar since mid-2002, traveling to the US is now cheaper by a similar quantum in rupee terms.
The same applies to students who are still in the process of finalising their study plans abroad. For example, a student's enrollment for a $1,000 course abroad would now cost Rs 44,000 instead of the earlier Rs 49,000!
Last but not the least: Considering that the government has been selling its stake aggressively in major public sector units in the recent past, and with a substantial chunk of this being subscribed by FIIs, the latter will have to shell out more dollars to pick up a stake in the company being divested, thus aiding the governments build up of reserves.
Now, let us consider the other side of this coin, i.e. the disadvantages of currency appreciation:
Exporters disadvantage: The exporters are at a disadvantage owing to the currency appreciation as this renders their produce expensive in the international markets as compared to other competing nations whose currencies haven't appreciated on a similar scale.
This tends to take away a part of the advantage from Indian companies, which they enjoy due to their cost competitiveness. However, it must be noted that despite the sharp currency appreciation in recent times, Indian exports have continued to grow. This is vindicated from the fact that while in the month of February 2004, India's exports were higher by 35 per cent over the same month previous year, in the first 11 months of the current fiscal, Indian exports have been higher by 15 per cent year-on-year.
Dollar denominated earnings hurt: The strengthening rupee has an adverse impact on various companies/sectors, which derive a substantial portion of their revenues from the US markets (or in dollar denominations). Software sector is the best example, which is adversely impacted by this appreciation in rupee.
To combat this, Indian software companies need to hedge their dollar earnings, which involves a cost. Further, their earnings tend to face pressure because of the fact that while a major part of their revenues is in US dollar terms (as exports form a major source of their revenues), the costs incurred are in rupee terms, as most of the work is done offshore (in India).
Other sectors that tend to get hit by this phenomenon include the domestic pharma and textile industries, most of which have a similar revenue model.
While there are advantages as well as disadvantages of a rising rupee, one needs to understand whether the rise in the rupee is sustainable to derive any reasonable conclusion at this stage. For one, the weakness of the US dollar is largely due to the relative unattractiveness of US assets.
This is in part due to a very low interest rate regime prevalent in the US currently. Already there are indications that this low interest rate regime may not be sustainable for long. This means that US interest rates may go up and this is likely to strengthen the US dollar.
Thus it is believed that the rise of the rupee may not be sustainable for long. Without waiting for long, India may have to ascertain the benefits or otherwise of a falling rupee.
Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.
