In normal circumstances, with the growth in the economy, appreciating currency and the consequent increase in reserves is a sign of healthy economy. But at present juncture some specific conditions prevailing in India, point out towards some serious concerns in the matter. These factors require immediate intervention and government attention.
Rising rupee has become the cause of immense worry amongst all, especially small and medium exporters and others in the manufacturing sector. Rupee which used to sail around Rs. 45-46 to a US dollar is now at around Rs. 39.50. This has all happened in a year'sspan. It is not only that the rupee is appreciating; it is the dollar, which is weakening. Depreciation of dollar has its own pitfalls so far as our country is concerned.
Causes of concerns
Normally trade deficit leads to depreciation in the currency thereby helping in balancing the international trade of the country by increasing the exports. However, despite the persistent trade deficit our currency is appreciating which is due to huge inflows of foreign exchange and therefore it is not leading to improvement in the balance of trade situation.
Secondly, if this inflow was of good quality and not consisting of so-called hot money, which is primarily short term in nature, this would not have been that harmful.
Thirdly, if the foreign exchange reserves created out of this inflow had been properly deployed and invested in acquiring proper assets abroad and not in purchasing treasury bonds in US, the adverse situation arising out of increasing reserves could have been avoided.
Fourthly this inflow and investment in real estate is leading to inflation in land prices which is causing trouble for industries and housing sector.
Finally many of the PE funds are by way of replacement capital through mergers and acquisition and not as direct investments to create fresh assets and for new green field projects.
Maximum inflow has come when the rupee was lying low during the couple of years. Now that the rupee has gained ground, any remittance out of the country will unduly enrich the foreigners, who may not sincerely be interested in the development of our country. Just parking of funds by overseas investors is giving good returns to them. India has given 48 per cent return in one year in US $ terms. FII investment is creating extreme volatility in markets, which is harmful to economy and spoiling investors? confidence.
If these issues are properly tackled by the government, the manufacturing sector will also be in a better situation and inflated asset value syndrome could be avoided.
Direction of international trade
As per the figures released by the government for Balance of Trade of the country during April to December 2007, exports stood at US$ 111 billion as against imports of US$ 169 billion. Out of the total imports non oil imports grew at US$ 120 billion and oil imports stood at US$ 49 billion. During this period of nine months, non oil imports rose far more higher by 33 per cent as compared to the same nine months of 2006. Oil imports rose by 11.68 per cent, which may be considered normal.
The alarming 33 per cent rise in non oil imports points towards an alarming trend i.e. in spite of the strengthening of rupee which should lead to fall in value of imports, the imports are increasing. This is the result of local manufactures becoming traders, for whom it is profitable to close their industries and become importers.
Another factor which requires attention is that the asset inflation has led to a situation where industrial houses find it beneficial to turn into real estate developers. Glaring example is of Escorts, which is a manufacturing concern and recently it has announced starting real estate development activity. Ultimately by change in the composition and character of manufacturing sector this phenomenon will also have a negative impact on employment.
Exports during first nine months of current fiscal grew at 7.7 per cent as against around 25 per cent growth during the same period last year. On a conservative estimate with strong rupee it is likely to fall further for the whole year, which is a very bad trend for our economy.
How much is good reserve is a difficult question to answer. The foreign currency reserves must be sufficient to meet our import demands as well as must ensure to take care of crisis in case of sudden withdrawal of foreign investors from our markets.
Some other reasons for this unhealthy trend