Don't bet on a rupee devaluation

Steven Philip Warner | August 2016 Issue | The Dollar Business

There is no overnight waking up to a shock like the one that London witnessed when UK bowed out of EU. Stock traders on Paternoster Square, bankers on Threadneedle Street, high-end shoppers at the Royal Exchange, pub-hoppers from Wapping to Hampstead and beyond – all of them are still finding it difficult to pause conversations on the tomorrow for London, England and Europe. And for the pound. So what started as a promise-triggered campaign by UK’s erstwhile PM to stay in a flawed Union, ended with Russia smiling quietly, US scratching its head for having lost its closest ally in a critical bloc and much of South Asia – including India – guessing who will topple next. And while UK has signed the divorce, the British get two years to conclude on the new terms of agreement with EU; most critically, on trade.
Perhaps this is how the 21st century was meant to unveil: the West with its fast draining influence over the world, and emerging nations getting the better share of innovation and trade. Agreed. It hasn’t been precisely that way, but keeping an India-centric view, you could say that while EU’s policymakers and exporters got off to a bad start to the summer, those in India had a happier update to share. In a year-and-a-half, India’s monthly exports rose (y-o-y) for the first time in June 2016. What makes the good news better is India’s Commerce and Industry MoS' confidence that the fall in exports has finally been arrested. It may however be too early to judge whether India’s exports have rebounded for good.

A Marginal Respite

The 1.3% y-o-y jump in exports is too marginal a leap for comfort. Think of what happened to China. In March this year, after a wait of just 8 months, its exports grew by a much bigger 10.7%. Then, everyone was hopeful that China's exports was back on track to break records set in 2014. Since March, both May and June have seen the nation reporting deflated y-o-y export figures. India may have aced the exports test in June. But a 'back to square one' script could be written in just a month.

While India's exports rebounded in June, imports continued to slide y-o-y. While this is not a complaint altogether (the fall in imports was a result of reduced gold and oil import bills), it does point to the fact that despite recent rebounds, commodity markets globally continue to remain in a daze. Forecasts for exports in the next quarters aren’t very bright for quite a few of India's manufacturing industries either. Apparel and textiles, petroleum products, two-wheelers, and gems and jewellery, are some segments that will continue to face the heat. For many services, the same is true for a variety of reasons – crude prices, forex crisis in Latin American and African markets, uncertainty over a revival in global economic activity, Brexit and other potential EU exits, political tension across many countries, etc. Indian exporters will continue to be tested on how swiftly they are able to recalibrate strategies in times when the super spirit of hyper-globalisation has taken a back seat.

A Case Of (in)sanity

Hyper-globalisation is something that is not permanent. Historically, whenever world trade to GDP ratio has broken through the 30% barrier, it has been found to be unsustainable. And what always follows hyper-globalisation is a downturn. You could perhaps imagine consumer nations having imported so much, manufacturing nations having gathered mountain-loads of finished products in their backyards, and servicing nations having built such great human and material asset base, that the combined, swollen pie of goods, services and assets, becomes far too impractical for regular consumption. The first time this happened in the last 100 years was in 2008. One year later, the ratio (of 31%) was straightened out to 26%. The second time was between 2011 and 2014, when this ratio ranged in the 30-30.5% mark. In 2015, it was marginally corrected and fell below the 30% level (28.8% to be precise; TDB Intelligence Unit analysis). Though it’s hard to counter the truth that today’s world GDP is far more influenced by international trade, it is most likely that the ratio of 30% is far too ambitious and unstable. And there are two ways a correction can occur. Either a crash occurs within a year (similar to that seen in 2009; dashing India’s hopes of improving exports in the forthcoming months), or the process gets stretched over four to five years (reverse-mirroring the 2003-2008 era growth). This time thankfully, a crash seems to have been averted with the latter mode of correction prevailing.

Considering that, by 2020, when world GDP will have nearly made it to the $90 trillion mark (IMF forecast; as per US-based Knoema, estimates for world GDP in 2020 is $91.4 trillion), a healthy 25% world trade to GDP ratio would mean total world (goods and services) exports of $22.5 trillion. Considering India’s share of world trade of 2% in CY2015, its exports would then be $450 billion ($420 billion currently). That implies an increase of just $30 billion in five years. Now even if we consider IMF’s optimistic CAGR forecast of 4% until 2020 to be true, India missing its exports target set for 2020 (by FTP 2015-20) by half is enough a reason to believe that India’s exports may still have some hidden shocks in store that Twitter doesn't know yet.

Blame The Global Buyer…

As per a July 2016 report by The McKinsey Global Institute titled, Poorer Than Their Parents? Flat Or Falling Incomes In Advanced Economies, 67% of households in leading 25 First World economies experienced negative (or no) change in incomes in the decade leading to 2014 (compared with less than 2% who experienced that between 1993 and 2005). Reduced disposable income in advanced economies leading to new trade barriers being imposed by their governments and subsequent falling exports from developing economies is an expected chain of events. But look at the brighter side. The stillness of activity and subdued commodity prices give a determined nation enough time to build on its capital armoury. A pessimist would say, "Make in India wasn’t timed right." Truth is, it couldn't have been better timed! What good are goods when advanced economies themselves are waging a war against deflation?

Should We Weaken The Rupee?

Policymakers in India believe that the rupee has been very rigid in the past year-and-a-half and is overvalued. By how much? About 10% [as per the 36-currency trade weighted real effective exchange rate (REER) which was 110 as of May 2016]. Their belief is that if the central bank undertakes steps to devalue the rupee, India’s performance in exports will take off like a bottle rocket!

Slight reminders here. One, India’s rupee has been an underperformer against the greenback in the past 18 months. Yes, in 2015, while the rupee dropped only 5%, the Russian rouble, South African rand and Brazilian real fell by double digits against the dollar. But in the past seven months, while the real, rouble and rand have strengthened by 19%, 17% and 11%, the rupee has fallen another 2%. So here’s a number to digest – since January 2015, the rupee has depreciated by 8.02%! In short, if rupee devaluation is indeed some remedy then why is it that despite this ‘natural’ devaluation of the rupee by over 8%, India’s exports in June 2016 was 5.5% lower than that in January 2015? Discussing this very matter of rupee devaluation aiding India's exports, with a representative of The Dollar Business in Hyderabad in late June, RBI Governor Raghuram Rajan asserted that “Rupee devaluation may not boost exports from India. Moreover, it will have inflationary impact offsetting any benefit to the country’s economy. The current value of rupee is pretty reasonable. Cheaper prices may allow to export more but it also makes imports costlier. Often, exporters import a lot of what they export. It is obvious that just devaluing the rupee won’t help every exporter. Once we start devaluing, there is no end to it." Even the RBI Chief feels that worrying about the rupee and using the currency wand to change outbound trade outcomes is less wiser than imagined.

Having said that, there is obviously the paradoxical situation (and one that’s in sync with economics) that because the rupee depreciated in the past 18 months, overseas economies who had otherwise become reluctant to spend on Made in India imports started demanding more of Indian goods. But should India only pray for the rupee to fall further and further for it to be able to support its export numbers? From a situation of being overvalued, if a country’s currency becomes undervalued, that has dire consequences too! There are lessons to learn from both Japan and China here.
And what if it all leads to another currency war?
Seems unlikely? So did Brexit!

An Unlikely Currency War?

There are two parts to this. First – a quick talk on the fundamentals that underlie the Indian rupee’s value. Improved deficit figures (both trade deficit and CAD), consistent fall in short term external debt, steadily rising forex reserves (India's forex reserves have jumped by 30% in the last three years; enough to counter a repeat of the 2013 FPI outflow), etc., make one believe that the rupee will in the course of 2016, not fall too heavily against the dollar. And then RBI's new Chief may be forced to take adequate action that could make India responsible for another currency war. Those last two words bring me to the second issue – currency war.
Why is such a potential attack on capitalism, designed by governments of leading nations, so dangerous? Two checks again. One, state of exports of leading nations. China’s case of wobbly exports is a fact understood by every pebble. The second-largest exporter USA has not reported a y-o-y gain in monthly exports in 29 long months. Globally, leading exporters are battling an unnerving and oscillating situation. If you glance through the list of top 25 merchandise exporters in Q1, 2016, you'll find that all except two reported a negative change in quarterly exports (y-o-y; refer to the table titled 'Quarterly Exports Growth of 25 leading exporters').

Two, currencies. Like in the case of India, what’s the sureshot way of inflating exports for all? Currency devaluation, of course!

Now combine these two facts – one, countries around the world worried about their exports not shooting skywards and two, rampant devaluations (the one single solution for all these nations). In more ways than one, a repetition of the currency war that broke out in the 1930s (when countries abandoned the gold standard during the Great Depression) with nations around the world devaluing their currencies to stimulate their exports, increase employment and manufacturing within their boundaries and cripple sovereign competitors seems likely. In recent years, Japan and China have forever been at it (why even waste brainspace debating that). So has the European Central Bank with its QE stimulus programme in 2015 and recent cuts on deposit rates which at present sits at a negative 0.40%! [For BOJ and ECB, the moves have only backfired!] US undeniably has had its fair share of competitive devaluation under its two rounds of QE. UK with the exit from EU has become a “devaluationist by default”. South Korea, Australia, Brazil, Malaysia…the list of significant and insignificant nations in the race to the bottom with their central banks taking turns to fire in the dark with monetary policy canons to deliberately weaken their currencies could mean something disastrous. Given the current global consumption scenario, and in a system where there is literally no currency anchor – gold, dollars, Special Drawing Rights (SDRs)...nothing – India should avoid taking the first step to being the one to join the devaluation pack and instead work on directional forecasts-led exports strategy. "Currency devaluation as a path to increased exporters is not a simple matter. It may lead to higher input costs, competitive devaluations, tariffs, embargoes and global recessions sooner than later," writes American lawyer James G. Rickards, in his NYT bestseller 'Currency Wars: The Making of the Next Global Crisis'.

The World Is Watching India...

In recent weeks, both ECB President Mario Draghi and Nobel laureate Nouriel Roubini have warned that a global currency war might be in the making. India doesn’t need to make matters worse. It’s the world’s fastest growing significant economy today (having clocked a GDP growth of 7.9% in the quarter ended March 2016) with the World Bank estimating that it will remain that way for the next three years atleast. The world is watching India.

It’s one of the only two economies amongst the world’s ten largest today, where deflation isn't a big trouble area for the central bank. And it’s one where both manufacturing and services have grown in excess of 7.0% in a tough year gone by. The world is watching India.

The International Energy Agency (IEA) expects India to surpass Japan as the world's third-largest oil consumer this year and become the fastest-growing crude consumer in the world through 2040 (India is expected to demand 6 million extra barrels – 25% more than China. While China appears fatigued, India's oil demand in the second quarter of the current financial year grew at the fastest pace for any first quarter period in the past 10 years.] The world is watching India.

“South Asia is expected to be the fastest growing subregion, led by India, whose economy has shrugged off global headwinds and is on track to meet ADB's March fiscal year 2016 projected growth target of 7.4%, supported by brisk consumer spending and an uptick in the rural economy. Growth in 2016 and 2017 is led by South Asia, and India in particular, which continues to expand strongly,” claims the Manila-headquartered Asian Development Bank (ADB). Doubt not – the world is watching India!
In such a scenario, where a nation is literally the posterboy of growth and development, a message like “happy without, troubled within” could upset all economic peace. And worrying about an overvalued currency and achieving growth in monthly exports by adopting means of competitive devaluation will do just that. The wiser game will be to work and prepare for a world that’s back to consuming at its best.

The Rapture

Imagine a scenario. What if tomorrow, Russia, tired of the dollar’s hegemony, decides to remove the roble’s peg with the dollar in favour of a gold currency or something similar? Worse, what if nations combine to break away from the dollar peg; say, both China and Russia do that with several others? Will India be prepared to take on the world? Absolutely not. But imagining no overnight rapture of sorts, even in a global world of deregulation marred with wrong intent, things will in all probability not get that dramatic. So instead of playing with currencies to support exports, steps taken to support exporters with stronger and significant policy pegs, and avoid policy bloopers (like the one in mid-June which saw a 20% export duty imposed on “locally produced sugar” with no note on sugar “imported for re-exports”, that resulted in about Rs.700 crores worth of sugar imported for refining and re-exports being stranded at Kandla and Mundra ports for weeks) would be more meaningful.

The world is watching India. And there are better strategies to solve trade woes than a manipulation of the domestic currency and hinge hopes on exports having hit the floor already. Let China do it. Let EU do it. Let everyone do it. None of them are the posterboys of macroeconomic growth at present. India is.

With popularity comes great power. And “with great power comes great responsibility”. Spiderman said it. Didn’t he?

Actually no. His uncle – Ben Parker did. Imagine how the easier answer isn’t always the correct one. It’s the same with most quick fixes to problems in modern capitalism.