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Exports: Big bang to a whimper?

Abheek Barua

Indian exports have been on a roll in the first half of this fiscal. After a flat run in 2001-02, merchandise exports clocked 13.4 per cent in the April-to-August period.

The trade deficit declined by 18 per cent in the first quarter over the previous year's level and the current account turned positive. As a matter of fact, this export recovery was a key factor in driving a domestic industrial recovery forward - the first five months of the current fiscal year saw average IIP growth of 5.4 per cent compared to 2.7 per cent in the previous year.

Unfortunately, it does not look as though this recovery is here to stay. The critical drivers of this boom - a rise in global incomes and improved price competitiveness - may both dissipate.

This article focuses on the second factor, the price factors that influence Indian exports and their recent history.

In the export context, price factors refer essentially to two things: the exchange rate and the difference between domestic and competitors' prices or, more precisely inflation.

For the competitive position to remain unchanged, any rise in the difference in inflation would have to be compensated by depreciation in the exchange rate.

This is also known as the principle of purchasing power parity (PPP).

If the currency depreciates by more than the inflation differential, the currency is undervalued and if it depreciates by less (or appreciates), it becomes overvalued.

Of course, if the inflation differential is negative, PPP warrants exchange rate appreciation by that quantum.

Price factors are particularly important for products that have close substitutes produced by competitors.

This is true of foodgrains, petrochemicals, basic chemicals, basic metals and the like where quality differences are often insignificant and the decision to buy from a particular country depends essentially on the relative price of its products.

It is also true of categories like gems and jewellery. India imports uncut gems and adds value through cutting and polishing, a relatively homogenous process where the cost and hence price advantage are critical.

The price factor is, of course, much less important when quality differences become important and each product occupies a niche.

Our index, the Crisil Parameter of Competitiveness (PARC), uses the PPP logic to analyse the recent history of the rupee's competitiveness.

Unlike the Reserve Bank of India's real effective exchange rate (REER) or the five-country REER that uses the currencies of large buyers (US, Japan and Euroland), the PARC uses the currencies of only major competing countries to measure the rupee's real exchange rate.

Thus while RBI assumes that Indian exporters compete with domestic producers of the buyer countries, PARC assumes that the competition is really with other countries who also sell to these large buyers.

The shares of India's competitors in global trade are used to combine the individual exchange and inflation rates.

The underlying assumption is that a country's competitive position vis-a-vis India is determined by its share in total world exports.

Thus a country with, say, a 5 per cent share in global exports is a stronger competitor for India than a country whose share is 3 per cent.

The lack of data (particularly on historic inflation rates) means that the list of currencies is by no means comprehensive - however, the seven countries (Brazil, Mexico, Thailand, Indonesia, Malaysia, China, Taiwan) we chose are fairly representative and are drawn from both Asia and Latin America.

Together, they account for 10.5 per cent of global exports. A rise in the parameter suggests undervaluation of the rupee and hence enhanced competitiveness of Indian exports.

The PARC climbed for the whole of last year, peaked in April 2002 and then started declining. The rise was for two reasons.

Over most of 2001 and the first quarter of 2002, the rupee depreciated by much more in nominal terms than competitor currencies.

The Thai baht, for instance, depreciated by 1.8 per cent against the US dollar between February 2001 and March 2002. The rupee dipped by 4.8 per cent.

This trend reversed in the second quarter of 2002 when the rupee started appreciating against the dollar and its rise outstripped the appreciation in other currencies.

Also, softer domestic inflation in 2001 implied that competitors' prices rose faster than India's keeping the difference negative.

From October 2001, however, the differential entered positive territory and continued to increase as domestic inflation picked up.

A rise in domestic inflation is bound to spill over to export prices as well and erode their price advantage.

The turnaround in export performance started in October 2001 appears to have responded to a rise in the parameter with a short lag.

The up-tick continued even after PARC started declining but that is hardly a consolation.

If this lag does hold symmetrically, the decline in PARC from March 2002 does not augur well for the second half of the fiscal.

There are signs that this decline has already started. August export growth, for instance, dipped to 6.6 per cent following two months of double-digit growth.

Global demand conditions are unlikely to offset the rise in the real exchange rate.

The recovery in US GDP in the first quarter appears to have been short-lived. Second quarter GDP growth dived to 1.1 per cent from 5 per cent in the first.

Most indicators suggest that this downturn is likely to persist. Global incomes and demand will mimic the US trend resulting in demand deflation for exports from all countries.

India is unlikely to be the exception.

Finally, what does this mean for the nominal exchange rate of the rupee versus the dollar over the next six months?

Periods of currency overvaluation or undervaluation are usually followed by phases of correction in the nominal exchange rate against the dollar.

In this case, the rising value of the rupee suggests a decline in the currency value in the near future.

The triggers for depreciation would be the decline in export growth and the hardness in global oil prices.

Portfolio inflows are unlikely to pick up much given the global scenario and the global apathy towards equities - particularly in emerging markets - and this would add to the downward pressure.

Thus, we see moderate depreciation (less than 5 per cent) of the rupee in the next six months.

The writer is senior economist at Crisil

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