Exports and the external economy

THE PACKAGE OF measures announced on Monday to lower the cost of export credit, although intended to be in place for just one year, has medium-term implications that extend even beyond the management of the country's external sector. A reduction by one per cent in the interest rate on short-term export finance, special terms for large export orders and easing of rules concerning medium-term credit are the key ingredients of the strategy to boost export performance. In the current fiscal year export growth has been negative, which is particularly disconcerting in the context of last year's robust 19.6 per cent growth. Based on recent developments in India's external current account, the RBI, among others, says that exports hold the key to a sustainable balance of payments. Ensuring adequate credit to the export sector and removing procedural bottlenecks will continue to remain the crucial ingredients of monetary and credit policies. During the Tenth Plan period the current account deficit is projected to go up sharply, which automatically means that the recent strides in export performance need to be consolidated and maintained.

Moreover, after September 11, international trade and commerce have been beset with a large dose of uncertainty and measures to prop up the country's exports were probably overdue. Even before the terrorist attacks, the general economic slowdown in the U.S. has taken a toll on the country's exports of merchandise and software. Currently, there are well justified fears over the future direction of oil prices and the consequent deleterious consequences for the balance of payments. Risk premia on all types of goods and services have already gone up. Elsewhere, in the developed countries, official policy has been proactive. For instance, monetary authorities of the U.S., the U.K., Japan and the European Union swiftly lowered their benchmark interest rates. Whether the RBI should have emulated them rather than announced a package sans a bank rate cut is a question that can only be answered with reference to each country's own economic circumstances.

Pertinently, in India, there are larger issues such as those relating to financial sector reform, from which an interest rate policy can never be separated. Officially, the RBI is committed to a softening of the interest rates. Indeed, over the past few years the lending rates have come down appreciably. A further across-the-board reduction - of a type a bank rate cut will signal - does not appear warranted at this stage. The Indian financial sector, groaning under a high level of non-performing assets, will be badly hit in a still lower interest rate regime. As it is, the latest reduction in the rate on export credit will strain banks' margins, but overall economic urgency seems to have swayed the RBI. A long-lasting solution to this dilemma can be had only if financial sector reform is persisted with leading to a sharp reduction in the transaction costs. An even starker dilemma exists for the central bank. The global uncertainty has caused the rupee to depreciate, at one stage to below Rs. 48 against the dollar last week. A classic rupee defence would have normally involved a hike in the interest rates. It is obvious that there is a deft balancing going on all the time - not just in achieving the monetary policy's stated objectives, but in rapidly realigning the policy to suit a dynamic environment.

For now, there can be no doubt at all that exporters stand to benefit through a combination of lower rates, a depreciating rupee and robust dollar premia. By factoring in the last, Indian exporters will be borrowing at rates comparable to the lowest offered anywhere in the world, an advantage that is unlikely to be articulated by the beneficiaries. An interest rate cut for them is a subsidy and all subsidies have a cost for the rest of the economy.

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