If we look at the rising rupee as an export burden, it is a problem. If we look at it as a source of cheap imports, it is an opportunity.
The rupee is increasing in value. Are we happy?
There is a story of two boys. Fond parents of one of them left a plate of sweets while the boy was sleeping. When the boy got up, instead of being happy for the sweets, he was furious: He wanted to know why he was not included in the party. In the second case,as a prank, the boy's friends messed up his room with horse dung, again while he was sleeping. When he woke up, instead of getting angry about the mess, he shouted with joy: There has been a pony in my room! Where is it?
This story contrasts two mind sets: One that sees problem in every opportunity and the other, which sees hope in every affliction. Currently, the rupee is increasing in value. It is increasing because foreigners are viewing India as the land of hope. Are we happy? Apparently not; we are looking at the flood of foreign exchange as a burden, as a menace.
Two scenarios
As a source of inflation, foreign exchange inflow is a problem. As a source of capital, the same inflow is an opportunity. Similarly, if we look at the rising rupee as an export burden, it is a problem. If we look at it as a source of cheap imports, it is an opportunity. Combining both, we can look at the situation either as a double jeopardy or as opportunity to kill two birds
with one stone. It is all in the mind.
Consider two scenarios: Foreign exchange inflows are picked up by real-estate speculators who push up housing prices. To meet that inflation, wages have to be increased, leading to a spiral of inflation. In the second scenario, the foreign exchange is absorbed by innovating industry to develop better technology. As a result, exports increase in value, leading to a spiral
of cumulative growth.
In the first case, speculators use foreign exchange to sell goods at inflated prices and profit at the expense of the consumer. In the latter case, innovators use the same foreign exchange to improve productivity; increase their profits by selling better goods. Speculators play a zero-sum, win-lose game; innovators play a positive-sum, win-win game.
Indian tourists third category
Foreign exchange consumers, such as Indian tourists abroad, are a third category. There was a time when Indian tourists used to buy everything on sight. Fortunately, manufacturers have improved so much that Indian tourists no longer indulge in binge buying the way they used to. Credit for this noticeable change in the behaviour of Indian tourists should go to our manufacturers who may not be great innovators but are good modernisers. In this respect, modernisers play a defensive game: they cut wasteful use of foreign exchange.
Smugglers are a category of consumers who drain the country's foreign exchange and salt it abroad with little benefit either to themselves or to the country. During the days when Indian taxation was expropriatory, we used to have lots of them. Even now, Indians are said to have billions of dollars worth of foreign deposits secreted abroad. They score goals against their own country.
Trade balance
We can look at the picture from another angle. At the time of Independence, the US dollar was worth Rs 4.76; now, it is eight-nine times costlier. There are two reasons for the decline of rupee value: One, productivity of tradable goods has declined compared to that in the US. (The productivity of non-tradable goods is immaterial.) Two, the US has brought to the market many innovative products for which it is able to charge monopoly prices. For instance, the prices US manufacturers charge for computers and life-saving
drugs have little relation to manufacturing costs.
The converse also is true: If the rupee appreciates, the shock can be absorbed either by increasing the productivity of our tradables or by exporting
high-margin products through innovation. Unfortunately, our new billionaires are mainly real-estate developers; there is not one Bill Gates among them.
Thus, trade balance depends on four kinds of players.
Innovators and modernisers play positively; speculators and smugglers play negatively. Consumers are mostly neutral. Wise macroeconomic policy should
discriminate: encourage innovators and modernisers; discourage speculators and smugglers (and leave ordinary consumers alone). Unfortunately, macroeconomic tools (interest rate manipulation, for instance) treat the economy as a monolith. Like rain, which falls both on the saintly and on the sinners, macroeconomic tools make no distinction between good players and bad ones.
Reward and penalise
Ideally, macroeconomic policy should reward those who create less than average inflation pressure and penalise those who contribute to inflation more than the average. Unfortunately, it is not easy to decide how much of price increase is reward for product improvements and how much of it is due to poor management. Hence, rewards and penalties based on sale prices lead to interminable disputes, enriching tax lawyers more than the economy.
On the other hand, a company that increases wage rates (not wage bills) faster than the national average generates demand-pull inflation. A company whose profit rates (not profits) are increasing faster than the national average contributes to cost-push inflation. Both kinds of businesses can be identified;both deserve to be penalised. However, firms in emerging areas (IT, biotech, for instance) will claim that they have no option but to go on raising wage rates because of the nature of skills required. That is not correct: Salaries in the IT industry are going through the roof not because their workers are skilled but because there is a shortage of talent. If our education system had produced enough (employable) IT specialists, there would have been no wage inflation in the IT industry. IT industries have been crying hoarse that applicants are many but employable ones are few. Therefore, it is
in trouble not because the rupee value is rising but because our education providers are doing a shoddy job.
Insufficient and/or inappropriate education is the ultimate cause of wage inflation. Hence, bettergovernance is what we need; clever economics is no
substitute for good governance.
The real challenge
After much hesitation, as traditional Economics dictates, the government has cut interest rates. Hesitation, because nobody can predict reliably in which direction, and to what extent, the economy will turn when interest rates are cut. Prediction is difficult because, as explained earlier, macroeconomic
tools do not discriminate between bad players and good players. Interest rate management is like aspirin; it is a pain killer, a palliative. Pain persists when too little aspirin is taken. If too much is consumed, side effects, such as internal bleeding, make matters worse. Similarly, if the cut in interest rates is too small, economic pain remains. If the cut is too large, the economy bleeds. Interest rate cuts do not cure but only provide a breathing space for the economy to correct itself. Rupee value is likely to continue to increase for many more years to come; it is going to be chronic problem. As interest rate cut is a short-term palliative, it cannot be the cure for a chronic problem: How long can we go on decreasing interest rates? Further, the cut deters not merely hot money but genuine investors too.
How to ensure better governance that increases the productivity of labour (and of capital) is the real challenge, not how far interest rate should be cut.
The rupee is increasing in value. Are we happy?
There is a story of two boys. Fond parents of one of them left a plate of sweets while the boy was sleeping. When the boy got up, instead of being happy for the sweets, he was furious: He wanted to know why he was not included in the party. In the second case,as a prank, the boy's friends messed up his room with horse dung, again while he was sleeping. When he woke up, instead of getting angry about the mess, he shouted with joy: There has been a pony in my room! Where is it?
This story contrasts two mind sets: One that sees problem in every opportunity and the other, which sees hope in every affliction. Currently, the rupee is increasing in value. It is increasing because foreigners are viewing India as the land of hope. Are we happy? Apparently not; we are looking at the flood of foreign exchange as a burden, as a menace.
Two scenarios
As a source of inflation, foreign exchange inflow is a problem. As a source of capital, the same inflow is an opportunity. Similarly, if we look at the rising rupee as an export burden, it is a problem. If we look at it as a source of cheap imports, it is an opportunity. Combining both, we can look at the situation either as a double jeopardy or as opportunity to kill two birds
with one stone. It is all in the mind.
Consider two scenarios: Foreign exchange inflows are picked up by real-estate speculators who push up housing prices. To meet that inflation, wages have to be increased, leading to a spiral of inflation. In the second scenario, the foreign exchange is absorbed by innovating industry to develop better technology. As a result, exports increase in value, leading to a spiral
of cumulative growth.
In the first case, speculators use foreign exchange to sell goods at inflated prices and profit at the expense of the consumer. In the latter case, innovators use the same foreign exchange to improve productivity; increase their profits by selling better goods. Speculators play a zero-sum, win-lose game; innovators play a positive-sum, win-win game.
Indian tourists third category
Foreign exchange consumers, such as Indian tourists abroad, are a third category. There was a time when Indian tourists used to buy everything on sight. Fortunately, manufacturers have improved so much that Indian tourists no longer indulge in binge buying the way they used to. Credit for this noticeable change in the behaviour of Indian tourists should go to our manufacturers who may not be great innovators but are good modernisers. In this respect, modernisers play a defensive game: they cut wasteful use of foreign exchange.
Smugglers are a category of consumers who drain the country's foreign exchange and salt it abroad with little benefit either to themselves or to the country. During the days when Indian taxation was expropriatory, we used to have lots of them. Even now, Indians are said to have billions of dollars worth of foreign deposits secreted abroad. They score goals against their own country.
Trade balance
We can look at the picture from another angle. At the time of Independence, the US dollar was worth Rs 4.76; now, it is eight-nine times costlier. There are two reasons for the decline of rupee value: One, productivity of tradable goods has declined compared to that in the US. (The productivity of non-tradable goods is immaterial.) Two, the US has brought to the market many innovative products for which it is able to charge monopoly prices. For instance, the prices US manufacturers charge for computers and life-saving
drugs have little relation to manufacturing costs.
The converse also is true: If the rupee appreciates, the shock can be absorbed either by increasing the productivity of our tradables or by exporting
high-margin products through innovation. Unfortunately, our new billionaires are mainly real-estate developers; there is not one Bill Gates among them.
Thus, trade balance depends on four kinds of players.
Innovators and modernisers play positively; speculators and smugglers play negatively. Consumers are mostly neutral. Wise macroeconomic policy should
discriminate: encourage innovators and modernisers; discourage speculators and smugglers (and leave ordinary consumers alone). Unfortunately, macroeconomic tools (interest rate manipulation, for instance) treat the economy as a monolith. Like rain, which falls both on the saintly and on the sinners, macroeconomic tools make no distinction between good players and bad ones.
Reward and penalise
Ideally, macroeconomic policy should reward those who create less than average inflation pressure and penalise those who contribute to inflation more than the average. Unfortunately, it is not easy to decide how much of price increase is reward for product improvements and how much of it is due to poor management. Hence, rewards and penalties based on sale prices lead to interminable disputes, enriching tax lawyers more than the economy.
On the other hand, a company that increases wage rates (not wage bills) faster than the national average generates demand-pull inflation. A company whose profit rates (not profits) are increasing faster than the national average contributes to cost-push inflation. Both kinds of businesses can be identified;both deserve to be penalised. However, firms in emerging areas (IT, biotech, for instance) will claim that they have no option but to go on raising wage rates because of the nature of skills required. That is not correct: Salaries in the IT industry are going through the roof not because their workers are skilled but because there is a shortage of talent. If our education system had produced enough (employable) IT specialists, there would have been no wage inflation in the IT industry. IT industries have been crying hoarse that applicants are many but employable ones are few. Therefore, it is
in trouble not because the rupee value is rising but because our education providers are doing a shoddy job.
Insufficient and/or inappropriate education is the ultimate cause of wage inflation. Hence, bettergovernance is what we need; clever economics is no
substitute for good governance.
The real challenge
After much hesitation, as traditional Economics dictates, the government has cut interest rates. Hesitation, because nobody can predict reliably in which direction, and to what extent, the economy will turn when interest rates are cut. Prediction is difficult because, as explained earlier, macroeconomic
tools do not discriminate between bad players and good players. Interest rate management is like aspirin; it is a pain killer, a palliative. Pain persists when too little aspirin is taken. If too much is consumed, side effects, such as internal bleeding, make matters worse. Similarly, if the cut in interest rates is too small, economic pain remains. If the cut is too large, the economy bleeds. Interest rate cuts do not cure but only provide a breathing space for the economy to correct itself. Rupee value is likely to continue to increase for many more years to come; it is going to be chronic problem. As interest rate cut is a short-term palliative, it cannot be the cure for a chronic problem: How long can we go on decreasing interest rates? Further, the cut deters not merely hot money but genuine investors too.
How to ensure better governance that increases the productivity of labour (and of capital) is the real challenge, not how far interest rate should be cut.
