Economics Assignment

Economics ASSIGNMENT

A Report on: Effects of Rupee Appreciation

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TABLE OF CONTENTS

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ACKNOWLEDGEMENT

The following report prepared on “Effects of Rupee Appreciation” was a great learning experience. We got to learn a lot about the topic and current scenario which facilitate the trade all over the market.

WE are very thankful to our faculty Dr. Kishor Bhanushali for giving us this opportunity to know the practical aspects of this subject of Macroeconomics and the invisible factors which are involved in it. We are also thankful to the director of our institution Prof. Bala Bhaskaran for his support and inspiration. Last but not the least; we are thankful to all our classmates for their inputs and support.

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Introduction The Rupee now has become significantly more expensive in comparison to the Dollar. Rupee appreciation is negatively impacting the top line and bottom line of exporters. Export competitiveness is affected with the rise of the Re against $ - It is likely that business may be diverted to other low cost destinations. India will need to take appropriate steps if it is to continue being a prominent exporters’ market. India has an export target of USD 160 billion this year. If the Rupee appreciation continues at this pace, it is likely that India will miss the export target by about 15%. Rupee has appreciated by almost 8% during March to May 2007. Appreciation was much higher against US Dollar compared to Euro. Another round of appreciation is visible between AugustOctober 2007, which has been relatively mild. Import: When you import (buy from foreign markets) goods, you have to pay in dollars. India's chief import is crude oil. Suppose a barrel of oil costs $100, as per earlier rates a company would have to pay about 4800 rupees($1=48 Rs) to buy a barrel, now can buy the same for 4000 Rs ($1=40 Rs.). So oil companies are the biggest gainers from the appreciating rupee. They are now getting oil at reduced prices but selling them to the customers at old rates, hence increasing their profits. Export: When you sell goods/services in foreign market you get paid in dollars. A lot of companies that have been asking the govt. and RBI for control of the appreciating rupee are export driven companies like big IT cos. who export software solutions and provide out-sourcing services. There are many others too like garment exporters and even automotive companies. the scene here is that, supposing a BPO company charged $100 for its services, it would be getting paid an equivalent amount to Rs 4800 as per old exchange rates, but because of the appreciating rupee, it now gets paid Rs 4000, and as the market gets increasingly competitive the company cannot increase the fee it charges the client to $120 to cover this loss, as it risks losing the client to some other company. Garment exporters are hit even stronger as they mostly survive on large dedicated orders and charging more to cover their losses can even result in cancellation of large orders and massive loss to a garment exporter.

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IMPACT ON THE VARIOUS IMPORTANT SECTORS The US dollar – rupee exchange rate is the current hot topic for discussions amongst economists. The 15 per cent (almost) appreciation of rupee over the last year has given way to many issues and arguments regarding its effect on the Indian economy and its different sectors and also its effect on the labor and job market. All the major currencies across the world have witnessed a rise in their value vis-à-vis the US dollar. The Canadian dollar appreciated by 23%, euro by 14.7% and the pound rose by 10.4%. Appreciation of Indian rupee (which appreciated by almost 9% between January and June this year) is being cited as the result of the increasing capital inflows and the RBI’s effort to intervene in the increasing inflation rates. But the contradiction is that the stronger rupee is having a gloomy effect on various sectors especially the labor intensive industries like leather and handicrafts based in the tier-II cities of India. When a company bills in dollars, each time the firm receives its payments and converts the money into rupees, it gets less of the local currency. In January, Indian exporters would have got Rs4,426 for every $100 of billings, while these days they would get only Rs3,943 for the same amount of dollars. Meanwhile, even as the firms are making less money on their exports, interest rates and inflation at home have remained high. Goods are about 3.02% more expensive now than a year ago as measured by the wholesale price index and interest rates are at a five-year high, raising the cost of doing business and pushing up wage bills. And for exporters, there is no respite because they haven’t been able to raise their prices. Smaller players who quote higher prices for future businesses risk being priced-out by competitors in countries such as China, whose economy thrives on its exports. The Chinese YEN is pegged to a fixed price range against the dollar, arresting large fluctuations in the currency. The appreciation of rupee has badly hit India’s exports (mostly to the US), and as a result many organizations export units have already shut down or reduced their staff considerably. We shall now discuss the effect of the same on different Indian industry sectors:

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Information Technology India has emerged as the most preferred and low cost destination for outsourcing the IT products and services. India has the advantage of providing services at low-cost because of the availability of the engineers and the developers. The effect of rupee strengthening against the dollar is that the average salary in the IT industry has risen considerably and, the East European and other Asian countries like Japan are also giving tough competition to the Indian IT industry. The short term impact of all these situations can already be seen in the industry with the diminishing profits of the industry. Also, the appreciation of rupee has led to decreasing number of projects and assignments. In recent years, the Indian IT industry has grown at a very fast rate. Even if the sector maintains the growth rate, the profit margins of Indian players will only get lesser because the appreciation of rupee is eating away the purchasing power of dollar. The lesser profits would also affect the investment in training and development of professionals, the infrastructure and the common practices of the industry requiring heavy investment. The worst effected will be the small players in the industry as rising costs and salaries and decreasing profits will be difficult for them to manage. All these factors can have adverse effects on the labor force of the IT industry.

Frontline IT Frontline IT stocks (SENSEX featured) have witnessed significant falls, despite the market being in the bull phase. Top line and bottom-line of IT/ITES players are being impacted negatively.  Large IT players: The top line is suffering, given a large percentage of sales of IT industry is export oriented. With majority of the costs in Indian Rupees, the bottom-line is further impacted.  For every 1% appreciation in the rupee, the operating margins (OPM) falls by 40-50 basis points (bps).  On a positive note, Indian Inc. is presented with a large scale M&A opportunity overseas. BPO and relatively smaller players  BPO work in India is being undertaken mostly in an offshore model and hence has been

severely hit with the Rupee appreciation.  According to Nasscom President, “Large IT companies are in a good position to counter the effect.  However, the BPO segment and small companies, with lower margins, will be hard hit“.  ITeS companies will face additional burden to the extent of 25% with the STPI scheme expiring in March 2009.

EXAMPLE:

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TEXTILE & APPAREL Industry Indian textile industry – which held a competitive position in the apparel and textile export to US-has been adversely affected by the appreciation in the value of rupee. The industry is witnessing a decline in the domestic textile and apparel export to US in the first half of year 2007. Although the total imports BY the US witnessed an overall increase by 5.70% over the last year, exports by Indian textile and apparel saw a decline by 0.21 %. The industry which was already facing sluggish apparel sales in the US has been hit by the strengthening position of rupee against the US dollar. The worst affected is the labor force of the industry. Approximately 10lakh workers are feared to lose their jobs due to the current scenario of the rising value of rupee. Also, as many as 80lakh workers are expected to be indirectly affected by the prevalent situation. The fear of losing their jobs is gripping the entire industry, right from the organization owners and the small scale workers. Many small scale units in tier – II cities have already faced the brunt and have shut increasing the unemployment in the sector.

LEATHER industry The same is the case with the Indian leather and handicrafts industries. Kanpur and the adjoining areas is the hub of India’s leather trade and US exports account for nearly half of the region’s leather trade revenues. The rise in the value of rupee has eroded almost all the profit margins of the exporters made from US shipments. Most of the companies have stopped taking fresh orders and decreased the number of employees as well as the number of shifts of the remaining employees. Wilting under the financial debts, many units have already have shut their business and with no new assignments coming their way, the remaining functional units are also almost out of business. The Brassware export business in UP and the handicrafts industry are also losing their business to countries like Sri Lanka, Pakistan, Bangladesh and even China, which are providing lower costs than India to the importers in US. The large agricultural and industrial base of India is being badly affected by the rupee appreciation. The extent and the long-term effects of the damage are yet to be seen. If the rise in the value of the rupee continuous, it will erode our competitiveness against countries like Bangladesh or China.

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AUTOMOBILE Industry A sharp hike in the value of the rupee, which has climbed 12% against the dollar since the beginning of 2007, is throwing India’s small and medium auto component makers out of gear. On an average, a stronger rupee has shaved off 10% from the export revenues of many small component makers in this period. Nissan does not sell in India at all. Its exports are concentrated in Australia, Europe, West Asia and the Far East. Barring Europe, where the company bills in Euros, about 80% of its export orders are dollar transactions. India’s auto component industry had revenues of about $15 billion (Rs59,050 crore) in 2006-07, according to provisional figures from the Automotive Component Manufacturers Association of India (ACMA). Small- and medium-sized enterprises make up almost 60% of the auto components sector in India. Exports account for 19.5% of total volumes at $2.93 billion. Any further appreciation of the rupee, say to Rs36-37 on a long-term basis, might lead to the closure of some small and medium companies, particularly those who are concentrating only on exports and have marginal sales in India. Many of the export contracts, especially those with vehicle manufacturers and top suppliers, are fixed-price contracts extending between one and three years, locking the suppliers irrespective of what happens to the rupee. The only exports that have not been impacted by a stronger rupee are to Europe where prices are quoted in Euros, but this makes up only one-third of all auto parts shipments out of the country. The rupee has marginally appreciated by 2% against the euro since the start of the year. For small companies such as Nissan, the challenge will be to maintain their production costs as well as to diversify into new products and markets. With margins continuously eroded that’s proving hard. Others such as Simmonds Marshall Ltd, which supplies nuts and bolts, have also been hit by the depreciation of the British pound since the UK is Simmonds’ biggest export market. The pound has weakened 7.36% against the rupee from its historical high of £88.4781 in December. The company’s exports, however, account for only 20% of its annual turnover of Rs24 crore achieved last fiscal. There has also been some market buzz that component makers have started negotiating their contracts in rupee terms. Though this is not always possible or practical. “Transacting in rupees would mean that we would be subject to domestic issues...these are things our customers don’t want to hear about,” said Sultan. He says customers rarely buy arguments on higher costs such as labor. Component makers say while the government had promised some fiscal rebates to help exporters almost six months ago, the only solution is to make lean their own operations. And some are also looking at more pragmatic ways to hedge against a rising rupee.

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Biggest Losers As per the estimation of FIEO, around 8 mn jobs likely to be lost in export intensive industries. There are few industries which are the heavily suffered from havoc (rupee appreciation) are given with available statistics: Textile and garments Leather Processed agriculture products Handicrafts Engineering goods Chemicals Marine Products

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6 lakhs job lost, loss in production capacity-2025% 7 lakhs job lost, reduced profitablity-75% around 20% job lost, cash loss of 15% 8 lakhs job lost, business loss-$ 7.5 bn 16 lakhs job lost, cash loss- 12-17% reduction in exports-20-25% reduction in exports-10%

A BOON OR A CURSE? From March 2007, rupee appreciation becomes an apprehension for us. It’s like thunder storm for exporters of our country especially (SMEs). Rupee appreciated by 13%, in the value of the rupee over the US dollar since March 2007 and 7% against a basket of currencies including the yen and this increase does not reflect economic fundamentals and is seriously hurting Indian industry’s competitiveness, margins and exports. Initially it was taken as boon by the Indian business community but due to various reasons it becomes a curse for Indian export community. According to various economists and experts, there are some factors which are boosting this issue like excess capital inflow, federal interest rate cut, poor government policies, political intervention etc.

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PREVENTIVE MEASURES What Corporate Sector needs to do? Analysts predict Rupee to continue to appreciate even if the dollar stops weakening. Few exceptional views are also available.  Proactive hedging policies is a must for US$ receivables.  Look for INR billing; promote “Brand India”  Billing in other currencies; Increase resilience through diversification in different regions (including domestic market),  Explore rate hike; Improve productivity through better Utilization ratios,  Increased billable hours each month  Increase working hours for the employees  Rationalize operational expenses, Shift to tier II & III cities and explore multi location delivery by setting up centers in other low cost countries.  Increase Average Price Realization : Move up the value chain by transferring low end work and retaining high value work Support from the Government – Critical for Survival Should the Government’ Intervene? If the Reserve Bank intervenes to stop the rupee from appreciating further, it may increase the profitability of export-oriented units and create more jobs, but that may, in turn, bring in an inflationary tendency to the market. Thus, the government is virtually standing between the devil and the deep sea. It's difficult to choose between inflation or unemployment. Possible Solutions • Extend : STPI benefits beyond 2009 • Provide : Service Tax exemption at first stage • Support : the Rupee and maintain a stable US$ rupee regime • Develop : the Infrastructure comparable to any developed country

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STEPS TAKEN BY GOVERNMENT The government has been monitoring the situation arising out of the appreciation of rupee. The appreciation of the rupee is a reflection, in part, of the growing strength of the economy and has positive economic benefits by way of cheaper imports and subdued impact on prices. However, the rapid appreciation of rupee in recent weeks has adversely affected exporters who had contracted export orders earlier. In July 2007, government had announced a set of measures aimed at providing relief to exporters. These related to accelerated reimbursement of dues to exporters, reduction in the interest rate on pre-shipment and post-shipment credit, and revision in drawback rates and DEPB rates. The total financial relief of these measures was estimated at Rs. 1400 crore. On September 17, the government had announced refund of service tax to exporters in respect of four services (Port Services, Transport of Goods, Transport by Railways, and other port service) for export purposes. In order to provide further relief to exporters, the government has taken the following measures which will come into effect immediately: 1. Increasing the number of Services for refund/exemption of Service Tax in respect of Exports: The list is being expanded to include three new services (general insurance service, technical testing and analysis service, technical inspection and certification service). Exporting community would be exempted from paying service tax for these services. 2. Provision to pay of Interest on EEFC balances: At present Exchange Earners Foreign Currency (EEFC) accounts are non-interest-bearing accounts. It has now been decided to allow interest to be paid on these EEFC accounts subject to: *Interest should be permissible on outstanding balances to the extent of US$ 1 million per exporter * Rate of interest may be determined by the banks * This measure would be valid up to October 31 * Such accounts should be in the form of term deposits with a maturity of up to one year 3.Interest on pre-shipment and post-shipment credit (extension of period & widening of coverage of sectors): The applicable interest rate on pre-shipment credit up to 180 days and post-shipment credit up to 90 days was BPLR minus 2.5%. In July 2007, the government had announced a reduction of this maximum rate to BPLR minus 4.5% in respect of the outstanding amount for the period April 1 to December 31. The government had agreed to provide the requisite interest subvention of 2% 13

points to scheduled commercial banks. This dispensation was made available to following sectors: I. The Sectors: (i) Textiles * Including handlooms * Readymade Garments (ii) Leather Products (iii) Handicrafts (iv) Engineering Products (v) Processed Agricultural Products (vi) Marine products (vii) Sports Goods (viii) Toys Now, it has been decided that the coverage would be expanded. The new list would be as follows: (i) Textiles * Including handlooms, jute and carpets * Readymade Garments (ii) Leather Products (iii) Handicrafts (iv) Engineering Products (v) Processed Agricultural Products (including processed cashew, coffee and tea) (vi) Marine products (vii) Sports Goods (viii) Toys (ix) Solvent Extracted De-oiled cake (x) Plastics & Linoleum . The period for which the reduction in the interest rate is applicable, is now extended from December 31 to March 31, 2008. The amount of subvention will be calculated on the amount of export credit from the date of disbursement up to the date of repayment or up to the date beyond which the outstanding export credit becomes overdue i.e., for pre-shipment credit up to 180 days and post-shipment credit up to 90 days, whichever is earlier. 4. Rs 300 Crore more for Vishesh Krishi and Gram Udyog Yojana (VKGUY): The product coverage under VKGUY, which is a scheme to promote export of agricultural and village industry products, is being expanded to include additional products. For this purpose, the revenue ceiling fixed for 2007-08 is being raised by Rs. 300 crore (from Rs. 200 crore to Rs. 500 crore).

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REFERENCES http://dyutita.blogspot.com/2008/01/technical-analysis-of-rupee.html http://www.thehindubusinessline.com/2007/07/23/stories/2007072350300900.htm http://answers.yahoo.com/question/index?qid=20071009222815AAbu0le http://wiki.answers.com/Q/Is_rupee_appreciation_good_for_india http://www.naukrihub.com/hr-today/rising-rupee-and-unemployment.html

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