Is India better off with a stronger rupee or a weaker one? Image: An Indian travel agent waits beside a board showing exchange rates in New Delhi, April 23. India's rupee is showing new muscle as it scales nine-year highs against the dollar, alarming exporters who sell most of their goods to the United States.
Despite complaints by some exporters in recent months about the negative effects of a stronger rupee on their operations, a Wharton expert says India will be better off with a stronger currency in the long run. "Indeed, it may be inevitable," said Professor Jitendra V Singh of the Wharton Business School.
'Indian firms should use the rupee's strength to their advantage by adapting their business models in innovative ways, much as Japan's automakers did during the 1980s,' Singh, who took over earlier this month as dean of Singapore's Nanyang Business School, said in an article in the August issue of Knowledge@Wharton.
'The notion that the RBI [Reserve Bank of India] can keep the rupee down may not amount to more than wishful thinking in the long term. The RBI cannot keep the rupee weak indefinitely; the rupee cannot stay down if the Indian economy is strong and the fundamentals keep pushing it up,' Singh said.
The Indian currency has risen more than 8 percent since March against the US dollar, in stark contrast to the currency's depreciation till 2002. Although the rising rupee has both good and bad effects, companies that earn revenues in dollars and whose costs are in rupees are worse off.
Singh explained why he thought Indian firms must rethink their business models. 'Indian companies should learn from Japan's auto makers' Image: Workers at Japan's auto giant Toyota Motors assemble the Lexus. When the yes rose against the dollar, Toyota kept product lines where they made the highest margins, such as the Lexus, in Japan. However, for lower-priced models -- where their profit margins were lower -- they moved production to the US.
Noting that the situation that Indian companies face today is broadly similar to that faced by Japanese firms when the yen began to appreciate against the dollar during the 1980s, Singh said that in later years, the yen appreciated to close to 80 to the dollar. 'Yet companies like Toyota, even as the yen grew stronger against the dollar, saw their US market share go higher. How did they manage that, and what lessons does it hold for Indian firms?' he asked.
'I believe there is a strong parallel here from which Indian companies -- especially, though not solely, the IT firms -- can learn some important lessons. If Indian companies compete mainly on cost arbitrage, they will find that as their costs rise because of the stronger rupee, they will increasingly become less profitable,' Singh said.
Singh admitted that it is also true that as the rupee appreciates, net margins at some companies erode more than at other firms and therefore, specifically, if Indian IT companies compete as low-cost providers of IT services, their competitive advantage will erode in a regime of a strong rupee.
He admitted that while the details of the two industries are quite different, the Japanese automobile industry can suggest some answers.
'Consider what leading Japanese firms like Toyota did as the yen strengthened against the dollar. For product lines where they made the highest margins, such as the Lexus, they continued production in Japan. However, for lower-priced models -- where their profit margins were lower and would have been eroded further by the rising yen -- they moved production to the US. They protected their margins on non-premium products by moving production -- and therefore shifting costs -- into dollar-denominated areas,' Singh said.
'They also reduced their vulnerability to further appreciation of the yen,' Singh added.
Singh argued that Indian companies should take a similar approach in response to this recent rising rupee regime and need to consider how to adapt their business models.
'To the extent that they compete primarily on cost arbitrage, the rising rupee will work against them.' 'Indian companies must think like global companies' Image: Founder and mentor of Infosys Technologies N R Narayana Murthy with NASDAQ President and CEO Bob Greifeld (6th from right) celebrate with Infosys officials during the NASDAQ Remote Opening Bell Ceremony at the Infosys campus in Mysore, July 31, 2006. According to Jitendra Singh, Indian companies will need to analyse their portfolio of costs and move production to where it makes the best economic sense.
One key question to ask is how to develop other sources of competitive advantage, such as building high-level capabilities which cannot easily be replicated by competitors, or how to change the mix of activities carried out in India versus other countries,' he said.
'Of course, in order to do this, they will have to change their mindset: They will have to stop thinking of themselves as Indian companies and think more like global companies of Indian origin,' he said.
According to Singh, Indian companies will need to analyse their portfolio of costs and move production to where it makes the best economic sense. He said that Indian IT firms are trying to address rising wage costs by moving production within India to lower cost regions like Kolkata or Bhubaneswar and to Tier-II and Tier-III towns.
'However, this will only offset a rising rupee to a limited extent, since the costs will still be in rupees,' he said.
Singh said if Indian firms were to follow this approach, there would be less reason to use the Reserve Bank of India to intervene to force the rupee down against the dollar.