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India’s Roller Coaster Rupee Threatens Long-term Prospects

India’s rupee experienced a tumultuous year, slumping to an all-time low last August at 68.85. And it declined again late last month, stung by a strengthening demand for the U.S. dollar.

Overall, the rupee was down 11.2% in 2013, making it among the most underperforming currencies in Asia, lagging behind only the Indonesian rupiah and Japanese yen.

The Indian government has tried several strategies to buoy its sinking currency, including pushing up market rates, restricting the importation of gold and luxury goods and making it easier to borrow abroad.

Economists seem conflicted over the impact the sharp fall the rupee is going to have over the future prospects of India’s textile companies. Most textile outfits have reported a marked increase in exports, celebrating the extra value they gain for dollar-denominated sales. Ready-made garment exporters also have cause for satisfaction since, after two years of stalled growth, they are finally seeing their exports in the ascendent.

And most of the reports regarding the ramifications of the rupee’s depreciation have been positive. According to a study issued by Crisil Research, India’s exports have made substantial gains compared with a limp 2012, in which exports to the U.S. and E.U. dipped by 7 and 15 percent respectively.

India has also benefitted from significantly improved stability with regards to output and factory compliance, particularly when compared to fierce, low cost competitors like Bangladesh. According to the Apparel Export Promotion Council (AEPC), major American and European brands have been gradually shifting more and more of their sourcing to India.

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However, not all exporters in India have been able to enjoy the monetary boon, especially given the rapidly rising costs of cotton. The rising cost of cotton has dealt a major blow to the profitability of small and medium-sized cotton exporters. Saddled with cumbersome input costs, and unable to hedge against price volatility with futures and options contracts, home-based exporters in places like Panipat, India are struggling to survive.

Most major exporters have managed to benefit from the weakening of the rupee against the dollar. Smaller exporters, though, have been crushed by the 15 to 20 percent spike in prices over the last few months. And whatever gains have been won by the strength of the U.S. dollar against the rupee have been eroded by cotton’s increasing cost.

Larger exporters protect themselves against the short and medium-term price volatility of cotton through hedging mechanisms. By purchasing cotton futures and options, they can make export revenues more predictable. Another added benefit of hedging is increased flexibility for cotton-related transactions since futures can be sold even when there are no buyers in the physical market. Smaller exporters, however, rarely have access to these financial instruments.

Some experts remain unfazed by the currency’s depreciation, theorizing that the culprit is a global slowdown, particularly impacting emerging markets, rather than a rejection of India by global investors. While India has certainly had its share of financial troubles, they haven’t been much more embattled than other developing economies from the perspective of currency strength, short-term interest rates or sovereign risk.

In fact, Param Sarma, chief executive at NSP Forex, expressed a qualified optimism: “The rupee’s outlook looks bright in 2014. Indian markets have withstood the tapering by the Federal Reserve. However, some risks remain on account of more aggressive tapering in the next year and the outcome of the general elections.”

India is more vulnerable than most nations to an investors’ strike if the markets freeze since its financing requirements amount to nearly $250 billion. Its current reserves of foreign currency covers this, but barely. For the sake of comparison, consider that Brazil maintains a total reserve more than double its gross financing needs.

The other problem confronting India is a sudden pessimism regarding its longterm economic outlook. Since equity investors are largely betting on India maturing in the next decade or so, and their investment capital accounts for more than 25 percent of India’s GDP, it is of paramount importance that they don’t head for the exits. Last August, even India’s President, Pranab Mukherjee, noted the “widespread cynicism and disillusionment” that has gripped forecasters of India’s fortunes.