By: Surinder Anand

The Indian economy today presents a bewildering picture of successes and failures generating a mixed feeling of hope and despair. The annual GDP growth rate of around 8.6 per cent during the last four years suggests that the economy is functioning quite efficiently. The Reserve Bank�s Industrial Outlook Survey reflects higher confidence and continued optimism surrounding corporate business activities. During January-March 2007, the overall business situation was assessed to be better than in the preceding quarter as well as in the corresponding period a year ago.

However, the Garments Exports which had been registering an impressive growth rate during the last few decades have recently shown a declining trend causing grave concern to the garment exporting community. The various factors have attributed to the fall in the growth rate of garment exports. However, the single most important factor contributing to the declining growth rate had been the persistent and significant appreciation of rupee vis-�-vis Dollar by about 10%. It has not only adversely affected the growth rate of garment exports but has also eroded profitability of exporters. The high transaction cost, hardening interest rate, rigid and outdated labour laws, poor infrastructure and recent slow down in the US economy have also affected the performance of garment exports.

The rupee is still going higher and higher, further lowering the profitability of exporters. The recent tightening of monitory policy by RBI to curb high inflation levels has also contributed to the strengthening of the rupee against dollar. A nation�s economy thrives only when its exports breathe free and register tangible and string less growth. The hardening of the rupee has brought hard times to the exporters in India. That export becomes less competitive and import lucrative is an open criterion whenever currencies tend to become strong. Garment exporters are no exception to this general rule of the international trade. If not dealt with promptly and effectively, the steep and sudden rise in value of rupee is all set to hurt exports performance. To combat the fluctuations in the value of the rupee, a careful assessment and close monitoring of the exchange rate should be undertaken to ensure that financial flows do not adversely affect the exporters. What makes the situation more difficult for the exporting community is the rising inflation rates resulting in the increased cost of raw materials rendering our goods expensive and non-competitive in the global market.

According to the recent statement of Dr.V.V.Reddy, Governor, RBI, the Indian foreign exchange market has been widened and deepened with the transition to a market-determined exchange rate system. Our exchange rate policy in recent years has been guided by the broad principles of careful monitoring and management of exchange rates with flexibility, without a fixed target or a pre-announced target or a band, coupled with the ability to intervene if and when necessary, while allowing the underlying demand and supply conditions to determine the exchange rate movements over a period in an orderly way. Subject to this predominant objective, the exchange rate policy is guided by the need to reduce excess volatility, prevent the emergence of destabilising speculative activities, help maintain adequate level of reserves, and develop an orderly foreign exchange market. The Indian market, like other developing countries markets, is not yet very deep and broad, and can sometimes be characterised by uneven flow of demand and supply over different periods. In this situation, the Reserve Bank of India has been prepared to make sales and purchases of foreign currency in order to even out lumpy demand and supply in the relatively thin forex market and to smoothen jerky movements.

The Committee on Fuller Capital Account Convertibility (CFCAC) chaired by Mr.S.S.Tarapore, former Deputy Governor, RBI had recommended that exchange rate should be managed around Real Effective Exchange Rate (REER), which is the weighted average of Nominal Effective Exchange Rate (NEER) adjusted by the ratio of domestic price to foreign price. NEER is the weighted average of the bilateral nominal exchange rates of the home currency in terms of foreign currencies rate which is an index of a basket of currencies of our major trading partners. The RBI from time to time revises the basis of the index keeping in view significant shifts in India�s trade towards developing and emerging economies and other major trade partners. REER can be a valuable input in formulating the exchange rate policy. The Committee has also made recommendations for development of financial markets, including the foreign exchange market. While commenting on the present Foreign Exchange situation Mr.Tarapore, has recently stated that �the Reserve Bank of India faces an unprecedented monetary policy quagmire which makes monetary policy formulation extremely difficult. India is still the flavour of the hour and there have been relentless capital inflows into the country. This could, however, change overnight. Now suppose the RBI does not intervene in the forex market, there would be an unbridled monetary expansion and at the same time there would be an appreciation of the Real Effective Exchange Rate (REER) i.e. the trade weighted nominal exchange rate adjusted for inflation rate differentials. A real appreciation of the rupee is clearly against fundamentals and is clearly unsustainable as it would imply an over-valuation of the exchange rate. Continuing with an over-valued exchange rate, along with excessive monetary expansion, is a sure invitation for a crisis. Foreign investors faced with an unsustainable appreciation of the rupee, excessive monetary expansion and consequential inflation would be well advised to encash on the stock exchange boom and exodus out of India. To put it bluntly, a prolonged and large REER appreciation would be suicidal for India as fundamentals will eventually require a sharp exchange rate depreciation. Indian industry, caught in the large oscillations of the exchange rate, will be badly hurt. The large capital inflows and large monetary expansion will exert a downward pressure on interest rates even though the inflation rate would be high. A REER appreciation is a totally inappropriate instrument to control inflation�. If we persist with such patently wrong policies, real GDP growth will go into a tailspin and there will be a resurgence of inflation.

It seems that the Government has now realised the gravity of the situation with the rupee rising to a new high vis-�-vis the US dollar. Mr.Kamal Nath, Union Minister of Commerce & Industry who had earlier sought the intervention of Prime Minister, Dr.Manmohan Singh, to help the exporters to overcome the present crisis has now proposed a package of wide ranging measures to soften the impact of rising value of rupee on exports. It would help the exporters to increase their competitiveness in the international markets. Mr.Nath admitted that due to rising rupee realisations of exporters have gone down, thus hurting their competitive strength.

Mr.Shankarsinh Vaghela, Union Minister of Textiles has also asked for the Prime Minister�s intervention to provide relief and exemption to textile exports affected by appreciation of rupee in the international market. The Union Finance Minister, Shri P.Chidambaram has also pointing out in his recent press statement that Government is taking steps to mitigate the financial hardship being faced by the exporters particularly in the labour intensive sectors like textiles. In this connection, it may be noted that in his earlier press statement Mr.G.K.Pillai, Commerce Secretary assuring some help to exporters against the appreciation of the rupee, had pointed out that the � Government will conduct a "micro analysis" of sectors affected by the appreciation of the rupee against all major currencies.

Mr.Rakesh Mohan, Dy. Governor, RBI in a recent statement pointed out that �though the Indian currency was market-determined, the Central Bank could step into ensure stability. He admitted that RBI did intervene in the foreign exchange market but it was really very small compared with the overall turnover in the forex market�. He further pointed out that rate of capital inflows and a sustained spurt in software exports were complicating exchange rate management. According to him, large capital inflows may result in overvaluation of India�s currency and erode competitiveness of traditional and goods sectors in the long term�.

Dr V. Krishnamurthy, Chairman of the National Manufacturing Competitiveness Council, has also expressed concerns over the impact of appreciating rupee in the manufacturing sector, especially with reference to the small and medium enterprises. He pointed out that "the rupee has appreciated by around 10 per cent in past 12 months, which is hurting the manufacturing sector, especially the SMEs. He added that though the Government was looking into the issue, measures needed to be taken quickly to provide relief to the SME sector.

In this context it may be noted that the withdrawal of 100% exemption to export earnings under Section 80 HHC of the Income Tax Act and other exemptions by the Ministry of Finance has adversely affected the export performance and consequently reduced the profit margin and competitiveness of Indian Garment Exporters in International Market. The hardening of Rupee during the last nine months has added fuel to the fire, further aggravating the present crisis being faced by Garment Exporters.

As the present international garment scenario does not reveal a rosy picture for the Indian Apparel Industry, the Finance Ministry should take immediate steps in line with the recommendations of the Ministry of Commerce to exempt exports from Service Tax and grant adequate fiscal relief including higher duty drawback rates and need based funds at reasonable rate of interest to compensate exporters for the financial hardships suffered on account of upward movement of rupee against the dollar. The Government should take immediate corrective measures to manage the currency exchange rate fluctuations by adopting effective exchange rate management policy. Re-adjustment of rupee is, therefore, imperative to protect the long term interest of exporters. The RBI should immediately intervene in the currency market to curb undesirable movements. The Government should take positive steps to reduce the transaction cost thereby lending a fresh impetus to the industry to improve its competitiveness in the international market.

"In a fast growing economy like ours conflicts between national interests and sectional interest can always be resolved.  There are numerous sectoral, political and economic interests and when we are working within the framework of democracy, the commitment to the declared objectives of the Government may not be very firm. Matters can turn worse when there is a coalition government with various pulls and pressures.  Our export promotion policies are a case in point.

It cannot be disputed that export promotion is absolutely necessary for self-reliant growth. Our commercial, fiscal, monetary and budgetary polices, particularly in relation to exports, need to be dovetailed to a greater extent than hitherto for achieving our export objectives and for assisting our exporters."

About the author:

Mr. Surinder Anand, the Executive Secretary of the Garments Exporters Association (GEA) is a post-graduate in Economics from the University of Delhi. He has 37 years of professional experience in industry associations. He has been with GEA since the last 10 years. His articles have been published in leading dailies of Delhi.

Mr. Anand had earlier worked with the Indian Newspaper Society, the All-India Manufacturers Organisation (AIMO), the Indian Spinners Association, the Institute of Economic Growth and the Shri Ram Centre for Industrial Relations.