The Message in India's Rupee Rise

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As U.S. politicians line up to bash Beijing for its weak currency and gigantic trade surplus, one message they might want to offer their constituents is, buy Indian. Unlike China, Asia's other emerging giant has allowed its currency to appreciate almost 9% against the greenback since January. You might not have heard much about that in the U.S. — where total imports from India last year amounted to $22 billion, compared with $288 billion from China — but in India the rupee's appreciation is one of this year's biggest business stories, as exporters and labor groups scream that the strong currency will mean lower profits and fewer jobs.

So, what's going on? The rupee exchange rate is neither completely free-floating nor fixed, but is "managed" by the Reserve Bank of India through buying and selling other currencies. Up until April, the Reserve Bank was buying lots of U.S. dollars — perhaps as much as $24 billion in the previous six months — to keep the rupee at around 44 to the dollar. But with investor sentiment so hot on India and money pouring in from abroad — international investors have bought more than $7.5 billion worth of Indian stocks so far this year, compared to $8 billion in all of 2006 — the Reserve Bank found itself having to spend more and more on foreign currencies just to keep the rupee stable. When inflation shot up to over 6% in April, Bank officials appeared to decide — they never comment explicitly on such matters — to stop buying dollars. The result was, over the next couple of months, a strengthening of the rupee to close to 40 to $1.

The stronger rupee hurts exporters because it makes their products more expensive overseas. Infosys Technologies, India's number-two software exporter, cut its full-year earnings forecast last week, blaming the rupee's sharp rise, which it said was hurting the company's operating margins. Analysts expect other big software and outsourcing firms, many of whom earn lots of their profits in U.S. dollars, to issue similar warnings when they announce their quarterly earnings this week. Indian news reports have also quoted an unnamed government official warning that the country would be lucky to match last year's total export figure — about $125 billion; way down from the $160 billion the government had forecast just three months ago — and also that up to 275,000 jobs might be lost as a result of exporters feeling the pinch.

The stronger rupee may have helped push inflation down, "but at what cost?" asks Paresh Nayar, head of currency and bond trading at India's Development Credit Bank. "Exports are slowing, imports are ballooning. Perhaps we should be more like China. Other countries might complain, but the Chinese still watch their exports boom and say 'Let the whole world cry.' "

But Armeane Choksi, chairman and managing partner of Hudson Fairfax Group, a U.S.-based investment fund focused on India, argues that the Reserve Bank is correct in maintaining its primary focus on suppressing inflation. If inflation spikes again, he says, poorer Indians will suffer most because food and housing will cost more. "The Reserve Bank is not an export promotion agency," says Choksi. "It's doing the right thing." A stronger rupee, he says, will also force Indian companies to become even more efficient, which will make them more competitive in the global market, especially as China's currency slowly appreciates over the next couple of years.

The strengthening rupee may also send an even more important signal: India is not China. It helps of course that India's trade surplus with the U.S. last year was just $11.7 billion compared to China's whopping $232.5 billion. But by allowing the rupee to strengthen over the past few months, India is showing it's prepared to play much more fairly in the global market. "India is seen as a more or less unambiguous ally [to the U.S.]," says Choksi. "China? Is it a threat? Is it a competitor? Is it a partner? We're still not sure."

Of course, the Reserve Bank could still intervene to push India's rupee lower again. There is some evidence that it did just that in a very small way last week. But both the anonymous government official warning of rupee-related job losses and investor Choksi see the rupee continuing to rise in the coming months. If that happens expect to hear a lot more bleating from India's exporters — and not a word of complaint from India's trading partners around the world.