Sep 27, 2012

Trade invoicing in INR: Some thoughts

Most of our trade is invoiced in Freely Convertible Currencies (FCC) such as Euro (around 8% of total), Pound (3%), Yen(0.5%) or USD ( 87%). In fact, to become eligible for benefits under our Foreign Trade Policy, one has to realize the export proceeds in FCC 'only', as per para 2.4 a of FTP (ignoring minor arrangements through Vostro/Nostro/ACU and Nepal/Bhutan trade)

The questions are: why do we have this practise? Is it good? What if we tweak it and allow people to inovice  and realize the money in INR and let them avail the benefits of FTP. And what determines the invoicing currency in international trade to start with? Will traders rush to invoice in INR if they are allowed to? And so on. 

We have this practice of invoicing/realizing in INR because our currency is not an international currency. Till we become fully convertible, it is not easy to be an international currency. Importers cannot (generally) ask the quote in INR as the exporters from abroad cannot hedge INR easily. Exporters from India don't invoice in INR as the realization has to be in FCC (ok, there are many other determinants, right from differential inflation rate of trading currencies, proportion of country's share in global trade, currency strength and depth of forex market, microeconomic choices of firm such as existence of substitutes in market, macroeconomic compulsions, Grassman's law, etc, which I won't get into, to keep the blog simple)

There is enough literature on what determines the currency of invoicing. You can read about it here, or if you you want to understand it through the example of Euro, you can see here in greater detail. One might add that a stable (low exchange rate fluctuations), low inflation, internationalized currency, is always a preferred choice for trade invoicing. 

However, I find that most of the studies on invoice currencies relate to FCCs. Our currency is not yet FCC, due to the last bit of capital controls that we still have on INR. So this issue presents unique challenges, as there are hardly any studies that are done for the transition effect of internationalization of a currency. Perhaps, Chinese RMB comes closer to our example, though they are ahead of us in internationalizing their currency. 

There was recently a circular doing rounds for feedback, which asked the view on allowing INR as the currency for international trade from India. That would mean, amendment of FEMA, and amendment of our FTP to accommodate this. There is no point in not amending FTP as it will skew the incentive away from INR in that case.

I feel it is a good step in right direction, if implemented  We have been cautious with captial account convertibility all these years, with good reason. I think, the Govt is now warming up to the idea of opening up. We are following Chinese in this. The initial steps might see us getting into various swap agreements with multiple trading partners with whom we can have INR/XXX arrangements. This will slowly make way for other steps and gradual transition into FCC, over a comfortable period of time.  For sure, we are living in interesting times. 

Sep 12, 2012

The Phantom Menace

Can there be one 'simple' test for policymakers, that if applied to a trade policy measure, could come up with an answer that tells if the step is good or not? I tried to devise one and failed. However, I believe that one can spot a bad policy decision, after the policy gets implemented. I guess, that can be one of the tests.

It's a personal view, but I believe the measure to give duty exemption on imported luxury cars in the name of Export Promotion is one such bad measure. The Foreign Trade Policy (FTP), under chapter 5, has a policy that's called Export Promotion Capital Goods (EPCG) scheme. EPCG is an excellent scheme by itself, as it is aimed at capacity building of the industry. You can read more about it here and here. In short, one can import capital goods/machinery, without paying any duty on it, and export the manufactured items (ideally from that machine), over a given period of time in lieu of it. That helps the industry to climb up the technology ladder, by helping them invest in capital goods, and also helps exports. Fair enough. 

Under this chapter, 5.2 (h) says that motor vehicles can also be imported as capital goods by certain category of exporters. The category includes the hotels, travel agents, tour operators, transport agents, golf course owners etc. The idea is that vehicles are capital goods for this category, and by using these vehicles, we can serve foreign tourists better, in turn earning foreign exchange. And this is not fiction! This is exactly what FTP believes. And that's why this measure comes under the EPCG chapter. 

And there comes this foreign exchange earner, who owns a chain of hotels, and orders a Rolls-Royce Phantom under EPCG scheme, saving customs duties that run in crores. And there come his followers who are ordering such cars all over India. Of course, they are earning foreign exchange through their hotels or tourism business, but then, the question is, how much of  it is due to this capital good that came duty free. Do they really use it to ferry the foreign tourists, as our FTP assumes? In Phantoms? Really?

 DGFT made it mandatory to register such vehicles as taxis, if they come under EPCG scheme but then, as it goes wink wink nod nod, who checks on the ground? A little shade of yellow on white never hurts, and a traffic constable would never dare stop a Phantom or Ferrari and check for the shade of yellow. And you can see the link above to see how difficult it was to implement the taxi rule. 

That's when I thought again about the simple test to determine if the policy is producing intended effect. The complex one would have all the questions below (and more):

1. Is the export performance directly linked to the incentive? 
2. What will be the marginal change in export performance, if, this incentive 'alone' is withdrawn?
3. What will be the marginal change in export performance, if, this incentive 'alone' is introduced?
4. How does this incentive interact with other variables that effect export performance. 
5. What would the be demand for the incentive itself, if other variables (such as duty structure) is tweaked. In this case, what would happen if the duty on assembled cars is reduced from 180% to say 10% of CIF value. Would the people still queue up for the EPCG? (for sure, they will import more cars, but by paying duty)
6. What is effect of incentive on domestic industry. Does it increase local production or increase imports? 
and so on...

And to make things simple, for this case, I thought of this test:

What is the incremental, direct, foreign exchange earning due to Rolls-Royce Phantom? 

But then, the simple test failed the generalization principle. And I ponder further.

Disclaimer: I would love to own a Phantom myself. And I don't envy who do!