RPT-INSIGHT-Killing the goose: Why Indian exports need more than a cheap rupee

Mon Sep 9, 2013 11:03pm EDT

By Manoj Kumar and Frank Jack Daniel
    NEW DELHI, Sept 10 (Reuters) - The upside of the Indian
rupee's slump is an export boom that sets the economy straight,
right? Wrong.
    Prime Minister Manmohan Singh echoed classical economic
theory when he told parliament last month that the
plunging rupee, which has lost 18 percent against the dollar
since selling pressure picked up in May, would spur exports and
discourage imports.
    Some industries are bracing for a depreciation bonanza
and exports are already climbing. They rose at a double-digit
pace over a year earlier in the last two months, but for a hosts
of reasons, Asia's third-largest economy is unlikely to see the
sort of sustained export-led revival that nursed the Tiger
economies to the east back to health after the 1997 crisis
decimated their currencies.
    A multitude of stumbling blocks mean that exporters, from
farmers to factory owners, are ill-placed to reap the benefits
of the rupee's slide: bad news for policymakers and investors
looking for a silver lining in India's worst economic slump in
20 years. These hurdles range from erratic taxes throttling
special export zones to a cash crunch and clogged ports.
    "Notwithstanding the rupee depreciation, relatively high
inflation and infrastructural deficits continue to raise the
costs of production and constrain the ramping-up of exports,"
said Aditi Nayar, an economist at the rating agency ICRA, an arm
of the Credit Rating Agency Moody's Investors Service.
    "With only a moderate improvement in demand conditions in
key destinations such as the U.S. and Europe over the last six
months, foreign buyers will attempt to squeeze the margins being
earned by Indian exporters," she said.
    To make things worse, a dependence on imports for 80 percent
of India's oil needs plus a growing chunk of the coal keeping
the lights on will limit the cheaper rupee's ability to reduce
the world's third-largest current account deficit.
    Imports weigh heavily on Indian exporters too.
    Take the country's two main exports, petrochemical products
and jewellery, which together accounted for nearly a quarter of
India's $450 billion overseas sales last year. They are mostly
made with oil and gold, India's top two imports, which also cost
more now because of the rupee's diminished purchasing power.
    Manufacturing suffers for the same reason: parts used in
Indian car plants and factories assembling electronics largely
come from overseas, pressuring margins when the rupee drops.
    Hyundai Motor India Ltd, the country's leading car exporter,
is bracing for some price pain. Its finance and corporate
affairs director, R. Sethuraman, told Reuters the rupee would
not help exports for long, if at all.
    "Rupee depreciation has a limited advantage, and that too
only in the short term. Continuous depreciation will have a
reverse impact on pricing in the export market and an adverse
impact on input costs," he said.
 
 
    
    India's Motor City of Chennai, near the country's southern
tip, is an example of the stumbling blocks preventing exporters
from exploiting rupee weakness. The city is plagued by power
cuts, so manufacturers rely on expensive onsite generation.
Chennai port is so congested that trucks often spend three days
driving just 30 km (19 miles) from the factory district to the
port. A long-mooted expressway is delayed.
    Chennai's story is repeated across India. The boom during
the last decade was not matched by increased infrastructure, so
traders struggle to get their products to cargo ships on time.
Blackouts raise everybody's costs.
    After authorities shut down mines two years ago largely to
clamp down on illegal mining, iron ore exports fell from $6
billion to almost nothing. India's agricultural exports, swelled
by a bumper monsoon harvest, are limited by a global glut,
quality issues and government price restrictions.
    "We are sitting on a mountain of sugar. We can export 4-5
million tonnes, but we are struggling to sign deals for a few
thousand tonnes," said trader Kamal Jain. "There has been a drop
in currencies of other countries as well, like Brazil."
    
    LITTLE ITALY, VERY LITTLE
    Perhaps most damaging is the government's thirst for
revenue. The need for income to meet tough fiscal targets is
choking Special Economic Zones (SEZs) set up in 2005 to copy the
success of China's economic rise.
    Orient Craft thought big when it bought 400 acres of
farmland in an up-and-coming industrial town close to New Delhi
airport and a railway link to the west coast. The vision was to
make it north India's biggest apparel export zone, modelled on
Italy's traditional textile capital, Prato.
    As the global economy boomed in 2007, the aim to attract a
billion dollars of investment and create 20,000 jobs in a
"Fashion Village", seemed reasonable. Dupont was
interested, Commercial Director A.K. Jain said.
    "We started the Fashion Village apparel SEZ thinking it
would become a mini-Italy," said Jain.
    Orient Craft had the land designated as an SEZ, built a
13-km boundary wall and a warehouse, laid concrete roads and
planted trees. In all, it invested more than $30 million.
    What happened next helps illustrate the missteps of a
government that businesses say translates into lost opportunity
and wasted capital.
    Backed by a 10-year tax holiday, exports from the zones
soared 13 times over six years to reach $66 billion in 2010/11,
about 17 percent of India's $384 billion of exports that year.
    But in 2011, the government slapped an 18.5 percent Minimum
Acceptance Tax (MAT) on future profits - in effect, killing the
goose that laid the golden eggs, exporters say.
    The rapid exports growth from SEZs slowed to a crawl. New
investment tailed off, data from polling group Ipsos shows.
    Orient Craft threw in the towel two weeks ago, surrendering
its SEZ license. It was not alone: just 173 of 576 approved SEZs
are operating today. Close to 60 developers, including Reliance
Industries, a major exporter, have given up licenses.
    In February, an Ipsos survey of 400 companies operating in
SEZs found 62 percent of respondents had suspended plans to
invest further in the zones, while 75 percent thought the tax
hurt India's reputation.
    Jain said the zones were now economically unviable for
manufacturers, strong words from someone who is deputy chairman
of an industry chamber promoting exports from SEZs.
    "No promoter will ever think or advise the next generation
to invest in SEZs or any such project for many years," Jain
said.
    
    EXPORT PRIORITY?
    Exporters that do not depend so much on imports are
benefitting from the weak rupee. That includes Orient Craft; its
15 factories in the Delhi area have the fullest order book in
years.
    Textiles and pharmaceuticals, which exported $33 billion and
$15 billion respectively in 2011/12, are set for a boost.
    Service industries, including IT outsourcing, which account
for around one-third of India's exports, might also experience
gains. Reflecting that, India's IT stock index rose 36
percent from the start of May through Friday.
    Some players though, including IT solutions company Mindtree
Ltd, see problems ahead.
    "Our largest cost is people cost, and with the ... rupee the
way it's going, inflation will go out of control and obviously
salary costs will also go out of control," said Rostow Ravanan,
Mindtree's chief financial officer.
    For others, there is a sense of opportunity lost. In raising
rates to try to stem the currency rout, the central bank made it
harder for companies to expand quickly to meet new orders.
    To help, the finance ministry last month increased a subsidy
on interest rates on loans for exporters, but Naina Lal Kidwai,
president of the Federation of Indian Chambers of Commerce and
Industry, said high taxes are the main export drag.
    Some relief may be coming there, too. The trade ministry is
mulling a lower tax on iron ore exports. And the government's
top revenue official said India will soon clarify rules to help
resolve dozens of litigation cases that hit IT multinationals in
the past year as taxmen scrambled to meet the government's
fiscal deficit target. IT companies say these tax battles had
weighed on their growth. 
    "Priority sector lending" - cheap interest rates - are also
being discussed for exporters, a senior official at the
financial ministry said.
    That, exporters say, would help more than the rupee drop.
    "It is possible for (goods) exports to touch $350 billion
this year, surpassing the government estimate by about $25
billion if the government provides sufficient credit and
marketing support," said Rafeeq Ahmed, head of an exporters'
lobby group.