Rupee's Rise

Rupee's Rise : A Mixed Vice!

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Though the present spate of rupee appreciation is hurting exports and thereby adversely impacting growth and employment prospects, it is not an unmixed vice.

Ever since the introduction of economic reforms in 1991, the rupee-dollar graphs have been monotonously one-way, with the Indian rupee value declining against the greenback. However, in the past few years, the trend has reversed as the rupee has witnessed a steroidal increase, which saw it touching a nine-year high of 41.58 per dollar on April 24, this year (it had touched a high of 41.55 in 1998), which also made it the top performing Asian currency this year so far, fetching a return of about 7% against 3.6% by the second best performing currency, Thai baht.

The rupee which, in fact, has gained by 9% in the last nine months, may be tipping some more scale vis-à-vis the dollar if economists are to be believed. While this has importers celebrating, exporters are finding themselves at the receiving end. And if the rupee continues to strengthen, export-dependent sectors, such as textiles, IT, big pharmaceutical players, commodities, metals, hotels and transportation are likely to be hit badly; so far big IT firms have shown resilience, thanks to their part hedging of their dollar exposure. However, on the other hand, telecom, media, construction and engineering would be among the biggest gainers due to lower import costs.

Adverse impact

The impact of an appreciating rupee on software companies is well anticipated. Nearly two-thirds of the IT revenue coming to the country are dollar-denominated. And this has put tremendous strains on the revenues and margins of IT exporters. The trend has been more prominent in the fourth quarter results of the most big and small IT companies. For instance, Infosys, India's second largest software exporter: a strong rupee has dragged down its Q4 operating margins by 100 basis points. However, some deft balancing act helped the Bangalore-headquartered company somewhat neutralize the effect of a strong rupee and wage inflation. Wipro Technologies, the third largest software exporter, however, managed to lower the impact on its operating margins, which fell by a mere 0.3% to 24.3% for the year 2006-07 compared to 24.6% in 2005-06. It was also helped by improved realization as a result of better billing rates, expansion in BPO margins and increased utilization of resources. Satyam, which recorded 43% increase in net profit at Rs. 1, 404.73 cr, is also uncharacteristically conservative about FY08 revenue and EPS guidance due to persistently rising rupee. If the present spate of rupee appreciation continues, it is likely to erode 200 basis points from Satyam's operating margins. Operating margins of other IT players like TCS and Mastek too have been affected.

Sectors like textiles and garments and commodities which compete directly with exports from China, Pakistan, Bangladesh and Indonesia are likely to suffer. While the rupee appreciated by around 8% between March 6, 2007 and April 26, 2007, the Chinese yuan gained a mere 0.08% during the same period, and the Indonesian rupiah appreciated by 1.63%. The Bangladeshi taka appreciated by 0.49% while during the same period the Pakistan rupee more or less remained stable. Textiles and garments, which are known to operate at a profit margin of less than 10%, cannot increase the export price as it would nullify its export competitiveness.

Apart from textiles and IT, the sectors which generate a large chunk of their sales from abroad are pharmaceuticals and hotels. The pharmaceutical sector which accounted for an export revenue worth more than Rs. 21,000 cr during 2006-07, carried out over four-fifths of its export transactions in dollar. "Other than European Union everywhere else, the business is carried out in dollar. The continuing appreciation of rupee against the dollar and an ever-increasing interest cost within India will hit us hard," commented DB Mody, Chairman, Pharmaceutical Export Promotion Council (Pharmexcil). The smaller pharma companies unlike their bigger brethren, which are not in a position to enjoy the import gains, are likely to be hit worst.

Mining and metals companies are also likely to be hit hard as the gains to these companies accruing out of higher global commodity prices are likely to be offset by a weakening dollar. Almost 40% of the total revenues of National Aluminum (NALCO) and Sesa Goa are derived from exports.

A mixed blessing

Rupee appreciation is not an unmixed vice. Potential gainers of a strong rupee could be the industries which require huge capital expenditure. Telecom players such as Bharti Airtel's and Idea's capex run into billions of dollars. Hence, rupee appreciation will definitely benefit them. Even some textile companies, such as Gokaldas Exports, import half of their raw material requirements. And for gems and jewelry companies, the proportion of raw material imports can be as high as four-fifth of the total raw material requirements. Big industry houses such as Reliance Communications, Bharat Forge, Sun Pharma and Ranbaxy are likely to benefit from a strengthening rupee as they have huge exposure to foreign currency borrowings and have been the large issuers of Foreign Currency Convertible Bonds (FCCBs).

In the case of automotive industry, the biggest gainers are expected to be Hero Honda, Maruti, Tata Motors and Ashok Leyland, as the price of imported raw materials will cost less. According to a recent report released by DSP Merrill Lynch (DSPML), borrowers whose repayment is due will gain as they have to pay less to buy dollars either for making repayment or towards interest payment.

Engineering and aviation companies will also stand to benefit. The DSPML report stated that while companies like Jet Airways may lose on revenues, there will be more savings on fuel, lease rentals, interest and depreciation. Also, the management of Deccan Aviation announced that rising rupee would have a favorable impact on lease side. Most importantly, oil majors in India will be the prime beneficiaries of a strong rupee. Oil imports constitute about 30% of India's total imports and most of the imported oil is consumed domestically. So, unsurpris-ingly, oil companies will benefit from a declining dollar. For oil marketing PSUs—Bharat Petroleum, Hindustan Petroleum and Indian Oil—which import crude oil and process them to make petrol, diesel, LPG, etc., which is almost entirely consumed domestically, rupee appreciation is indeed welcome. If the prices of these fuels remain stable in the domestic market, these companies definitely stand to gain. According to Crisil Research, a rise of 1% in the value of rupee would translate into a Re. 0.2/liter impact on the retail prices of petrol and diesel.

Fundamental debate

A section of economists, however, feel that a rising rupee will hurt exports and thereby adversely affect growth and employment prospects. On the contrary, others opine that the RBI would be better off by not keeping the value of rupee down, as a rising rupee is unavoidable and desirable as well. Though in the present case, rupee value has appreciated from Rs. 49 to the dollar in 2002 to Rs. 41 today, i.e., an appreciation of almost 16%, practically in nominal terms, the value of dollar has declined against most other Asian currencies than against the rupee. The Thai baht, which declined to just 55 baht to the dollar during the Asian Financial Crisis, has gained appreciably and is now trading at 34 baht a dollar. Again, during the same period, the Indonesian rupiah doubled in value from 18,000 rupiah to the dollar to 9,000 rupiah. Even the value of the Korean won has almost doubled. So despite strengthening against the US dollar, the rupee has weakened against the currencies of many export rivals. However, the horrifying fact is that the Chinese currency yuan has appreciated by only 7% against the US dollar in the last two years which is indeed hurting India's export competitiveness. Again added to it is the scourge of slowdown in the US economy and its adverse consequence on IT and outsourcing firms. Moreover, the persistent wage inflation, with salaries rising as much as 20% to 25% a year, is throwing a challenge to Indian tech firms.

The rupee has been able to rise so far because foreign investments are pouring into India. Since January, FIIs have injected $2.5 bn into Indian capital markets. The RBI has stayed away from the market and has not intervened to rein in the value of rupee by sucking out foreign inflows. The RBI, at the same time, has been busy taming inflation by increasing the rate of interest five times in the past one year. It has also hiked the CRR and repo rates to contain inflation. But economists anticipate that the RBI can't let the rupee to appreciate inordinately. Once the inflationary pressures dissipate, the RBI is expected to intervene in the market. With the RBI being the apex monetary authority, it cannot let foreign capital inflows and remittances to belittle its domestic monetary policy agenda.

- Amit Singh Sisodiya and Sanjoy De