…to counter the rising rupee.
Professor Kaushik Basu of the Cornell University believes that the rise of the rupee against the dollar is inevitable in the mid-term. He also believes that the sudden collapse of the dollar is unlikely but there is not much that India can do to alter the current dynamics of exchange rates.
In recent days the rupee-dollar exchange rate has been, on average, Rs 39.3 per dollar. A year ago it was 44.7. This means that the rupee has appreciated against the dollar by 13.7% in the last year.
A gentle depreciation of the US dollar over the medium term seems to be unavoidable, given America’s over-spending. The big risk for India and the world is a sudden collapse of the dollar. This is unlikely, since a dollar meltdown is against the interest of all major players, but not impossible. It needs to be understood that the source of the rupee appreciation is, largely, outside of India. Over the last year virtually all major currencies have been appreciating vis-à-vis the US dollar. The euro rose by 14.7%, the pound by 10.4%; the Canadian dollar by 23%, Sweden’s kroner by 13.7% – the same as the Indian rupee. Vis-a-vis all major currencies, outside of the US dollar, the rupee has changed very little. The exception is China. Its currency has appreciated but only by 5.7%. China has a different strategy. It wants to keep up a sustained subsidy to its exporters and continue to build up dollar reserves. This is costly but it gives China muscle against the US. [HT]
This is not very good news for Indian IT firms, whose revenues are generated in dollars and costs are denominated in rupees. The fear of a slowdown in growth and profits has led the IT companies to employ complex hedging strategies against a weakening dollar. Prior to taking over as the Dean of Singapore’s Nanyang Business School a few months back, Jitendra V. Singh (then with the Wharton’s management department) had argued that Indian firms should use the rupee’s strength to their advantage by adapting their business models in innovative ways, much as Japan’s automakers did during the 1980s.
I believe there is a strong parallel here from which Indian companies – especially, though not solely, the IT firms – can learn some important lessons. If Indian companies compete mainly on cost arbitrage, they will find that as their costs rise because of the stronger rupee, they will increasingly become less profitable. Of course, it is also the case that, as the rupee appreciates, net margins at some companies erode more than at other firms. Specifically, if Indian IT companies compete as low-cost providers of IT services, their competitive advantage will erode in a regime of rupee strengthening.
Instead, Indian firms should take advantage of this opportunity to adapt their business models. How can they do that? While the details of the two industries are quite different, the Japanese automobile industry can suggest some answers. Consider what leading Japanese firms like Toyota did as the yen strengthened against the dollar. For product lines where they made the highest margins, such as the Lexus, they continued production in Japan. However, for lower-priced models — where their profit margins were lower and would have been eroded further by the rising yen — they moved production to the U.S. They protected their margins on non-premium products by moving production — and therefore shifting costs — into dollar-denominated areas. They also reduced their vulnerability to further appreciation of the yen.
You may remember that during the 1980s, Japanese auto makers were facing a protectionist backlash in the U.S., and they were subjected to import quotas. Their strategy of moving production of lower-priced/lower-profit cars into the U.S. paid off in a couple of different ways. First, they were able to shift yen-denominated costs into dollars. Second, this was a quite savvy political move, because although these companies continued to gain market share in the U.S., there was little pressure to shut down their plants. Doing so would have meant a loss of American jobs.
I believe Indian companies should take a similar approach in response to this recent rising rupee regime. They need to consider how to adapt their business models. To the extent that they compete primarily on cost arbitrage, the rising rupee will work against them. One key question to ask is how to develop other sources of competitive advantage, such as building high-level capabilities which cannot easily be replicated by competitors, or how to change the mix of activities carried out in India versus other countries. Of course, in order to do this, they will have to change their mindset: They will have to stop thinking of themselves as Indian companies and think more like global companies of Indian origin. They will need to analyze their portfolio of costs and move production to where it makes the most economic sense. Notably, Indian IT firms are trying to address rising wage costs by moving production within India to lower cost regions — Eastern India (Kolkata, Bhubaneshwar) and to Tier II and Tier III towns. However, this will only offset a rising rupee to a limited extent, since the costs will still be in rupees. [IK@W]
This prescription may hold good for Indian IT companies and these companies would surely be considering taking the suggested route. However if the IT companies follow this advise blindly, it will have grave implications for the overall health of the Indian economic landscape. It helps to recount the happenings in Japan during that period -
But, by the late 1980s, the exporters found it harder to bear the burden. They were caught in a squeeze between high costs at home and a rising yen, which made it harder to pass on those costs in export markets. As a result, more and more of the efficient exporters were being driven overseas. They were investing in offshore markets rather than in Japan itself. Step by step, Japan’s efficient export sectors were being “hollowed out.” As this happened, the productivity of the entire economy started being dragged down to the level of the stagnant sectors.
…At the end of 1989, when Japan’s “bubble economy” was at its height, the country felt on top of the world. The crippling heart attack was but a few months away, but Japan felt stronger than ever. [BW]
India growth model has to focus on generating suitable employment for its large population. If the efficient sectors of the economy move out and only the inefficient sectors remain in the country, the employment inclusive growth plummets. It has serious social and political implications in a democratic society. In a sense, individual companies would progress but that growth would be at the cost of country’s economic well-being. It is nobody’s case that this movement of firms should be legislated against; such policy prescriptions are unviable, if not unthinkable, in today’s ‘flat world’ and damaging in the long run.
For other Indian exporters, such as from the manufacturing sector, of leather products and clothes, or of commercial produce like tea and coffee, who are in direct competition with other Asian countries (mainly China), this is not even an option. They will continue to seek RBI intervention to keep the rupee competitive against the dollar, and peg the rupee vis-a-vis the yuan. Notwithstanding the difficulties involved in managing the rupee-dollar rate, there is no option for the government but to manage the rates in the short to medium term. This will indirectly benefit the Indian IT companies as well; some of them may even defer the implementation of their long-term plans to their own detriment.