Increasing Rupee compared to USDollar
Bharatudaymission
Government of India is proceeding step-by-step toward making the rupee
fully convertible into foreign currencies. That would make it possible
for Indian citizens to buy dollars for capital investment in the New
York Stock Exchange. Presently it is possible to buy dollars only for
current transactions such as education, business travel and purchase
of magazines etc.
We have foreign exchange reserves of more than 100 billion dollars and
it is increasing everyday. Making the rupee convertible would bring
forth demand for these dollars from private investors and take away
the pressure from the Reserve Bank to buy the dollars endlessly. But
we must take a look at the long-term consequences of this policy.
There are three ways in which the dollars brought by foreign investors
can be used. One, the rupee can be made convertible so that our
citizens can purchase them for outward capital flows from India. The
East Asian countries adopted this policy in the nineties. They got
into crisis because of this policy. Their citizens too had started
sending their savings abroad when foreign investors began to withdraw
their money. That had led to a run on their currencies and a steep
devaluation of the same.
The second solution is that the Reserve Bank continues to buy the
dollars and accumulate foreign exchange reserves. This policy has been
adopted by China. This policy is also harmful because we would be
buying dollars the value of which is certain to fall tomorrow if not
today. We would have to incur heavy losses, as the value of our forex
reserves will decline along with that of the dollar.
The third solution is to allow the price of rupee to increase. That
would lead to less inflow of dollars. The problem here is that a
strong rupee would adversely affect our exports. The choice then is
between three potential problems: (1) due to outflow of our money; (2)
due to decline in the value of our forex reserves; and (3) due to
problems for our exporters. The three choices can be best examined in
the light of East Asian and Chinese experience.
The manufacturing activity of products like cars, textiles and toys
shifted to the Asian Tigers, as they were then called, in a big way in
the nineties. American companies like General Motors were closing down
their plants in the US and establishing new ones in Thailand. This was
leading to a huge inflow of dollars into East Asia just as there is a
huge inflow in India today due to the shifting of services known as
'outsourcing'. Those countries had large forex reserves and were
confident of their ability to handle foreign capital flows just as our
Government is today. Those countries had made their currencies
convertible just as our government is planning to do now.
The situation of those countries changed dramatically in 1997. The
demand for their textiles, cars and toys in the industrial countries
ebbed a little. That led to a reduction in the inflow of dollars into
those countries. The foreign investors became bearish and started
withdrawing their money. The citizens of those countries followed the
footsteps of the foreign investors. Soon the large forex reserves
disappeared and their currencies faced a steep devaluation. These
Asian tigers have still not recovered from that crisis even after six
years. This shows the dangers of making the rupee convertible on the
basis of large forex reserves. The experience of Latin American
countries like Argentina also points out to this danger. That country
had made its currency convertible. But the perception of foreign
investors changed and ultimately it had to suspend convertibility. Our
'huge' forex reserves can similarly disappear in a short time if the
rupee is made convertible.
China has followed the second policy. She has not made the Yuan
renminbi convertible. Chinese citizens do not have the right to buy
dollars for making investment in the New York Stock Exchange.
Manufacturing activity is increasing in China today in the same manner
that it did in East Asian countries in the nineties. This is leading
to huge amount of foreign capital inflows into China. The Central Bank
of China is purchasing these dollars and investing them in the US to
augment her forex reserves. The Bank buys as many dollars as necessary
to keep the value of the dollar stable. This is beneficial for the
Chinese exporters. The result is that China's exports are rising and
imports are comparably less. This is leading to greater income of
dollars from exports and less demand for the dollars for imports. The
Central Bank is buying these excess dollars and balancing the books.
But this formula can be successful only as long as the Central Bank is
willing to buy all the excess dollars.
Obviously there are limits to this policy because the trade surplus
will continue to rise as long as China keeps the value of the renminbi
low. The fundamental problem is that the price of goods produced in
China is less and that makes her economy competitive. Her exports are
large and imports are less. This leads to large receipt of dollars
from exports and less demand for them for imports. In a free market
the value of the renminbi should increase, the exports should reduce,
imports should increase and the books should get balanced. But the
Government of China refuses to acknowledge this reality. Instead of
allowing the renminbi to rise it is buying the dollars and
accumulating huge forex reserves. These reserves are like a cooker the
pressure of which is continually rising and can explode any day.
Both these policies are not durable. Instead we must allow the rupee
to rise against the dollar. This will spontaneously lead to reduced
inflows of the dollar. Indeed the problems of our exporters would
become worse. But that is the mark of a strong economy. A strong rupee
means that we can produce goods at low price. It means that we can
obtain high prices for small quantities of our goods. That must be our
target. We should not forget that a weak rupee was seen as an
indicator of a weak economy. Contrariwise a strong rupee should be
seen as a strong Indian economy.
We have been misled by the slogan of export-oriented growth. 'Exports'
mean that we give away more of our resources. We pack our precious
groundwater into wheat and sugar and export it. That is utter
foolishness. Instead of looking for larger exports we must develop our
domestic markets for higher growth rate.
The experience of the East Asian countries shows the dangers of making
our Currency convertible on the strength of short-term increase in
forex reserves. The ever-increasing forex reserves of China signal the
dangers of buying dollars in unlimited quantities. We must chart our
own course and let the' rupee appreciate and see fewer exports as an
achievement.