Jan 31, 2016

A case for trade invoicing in INR

Should it matter whether the international trade invoices are quoted in INR or USD?
A simple thinking says it shouldn't. When buying/selling a good or service we mentally convert the currencies in the head or a calculator and it doesn't matter much. Like an inch or millimetre, they seem to be just units with a floating (or fixed or pegged or whatever) conversion ratio. It appears that it is not so. It does matter, and with profound consequences.

Today, over 97% of India's exports are invoiced in freely convertible currencies (FCCs) mainly in USD. INR is not yet an FCC due to restrictions on movement and convertibility in capital account. The realisation of export proceeds in India need to be in FCCs as mandated by FEMA and the master circular on exports and imports. While para 2.52 of India's foreign trade policy allows export invoicing in INR, in addition to FCCs, the trade prefers quoting invoices and contracts in USD, Euro and other FCCs. It appears that it is a bad policy. A better policy might be to make it mandatory to quote all the invoices in INR.

There is an interesting working paper by Gita Gopinath hosted at NBER website. Some of the results discussed therein have profound consequence on the way we think about exchange rate effects on macroeconomics. And about how invoicing currency has a significant link with exchange rate pass-through, trade balance and imported inflation. Let me summarise some of the key takeaways, in applied sense. 

I had blogged earlier about how exchange rate has a lag effect of around a year and a half in India. A depreciation of INR today helps our exports with a lag of more than a year. It turns out that one of the reasons for this delayed pass-through is 'not' invoicing in INR. If we quote our trade in INR, the pass-through delay will reduce drastically. Empirical data, as quoted in the paper, supports this view. Therefore, if we want to take advantage of currency depreciation in boosting exports, a better way is to quote all our invoices in INR. A corrigendum of the pass-through effect is also that trade balance adjustments happen through exports in countries that quote in domestic currencies, and through imports in countries that quote in foreign currencies. Therefore, India would try to adjust it's trade imbalance through control of imports, whereas US would work through exports. That's an important point to ponder about.

Secondly, prices are sticky in their currencies of invoicing. This leads to a situation where INR depreciation leads to markup profits for exporters/windfall gains, and pain to importers (and vice-versa for appreciation). India being a net importer, it hurts as it imports inflation. Invoicing in INR won't do this. US is insulated from currency swing effects on domestic inflation as most of its trade is quoted in USD. Imported inflation stabilisation would become much easier if we decide to quote mandatorily in INR.

Now, if that's true, we have some further points to ponder about.

First, would it be sensible to force our trade to quote exclusively in INR, irrespective of currency of realisation? An amendment to FTP/FEMA might achieve this but a better way of going about it would be to internationalise our currency by making it fully convertible, and thus more acceptable as an invoicing currency. While the path to full convertibility is long, we might think of amending FTP/FEMA to make invoicing in INR mandatory for all goods and services. This, after careful consideration.

Secondly, we need to realise that while we quote in USD, a currency depreciation is not helping much, and the export boost has a significant lag of more than a year. Therefore, a competitive devaluation of our currency is not in good interest, given that it might import inflation. So, to that extent I stand corrected from an earlier post that recommended rupee devaluation.

PS: I have assumed hedging both ways or none, therefore, the points hold even with hedged currency exposure. 

Jan 9, 2016

Time for an RMS at DGFT?

DGFT is the body that deals with international trade policy making in India. Apart from making broad contour of policy, and issuing import export code; a mandatory document to start imports/exports in India, it also implements various tax nullification schemes (AA/DFIA), capital goods upgradation scheme (EPCG) and few schemes to offset infrastructural inefficiencies(MEIS/SEIS). It also runs a complaint resolution mechanism (chapter 8) in the area of international trade. DGFT implements various schemes through its field offices across the country. 

DGFT field offices are severely understaffed in the recent times. The retiring staff have not been replaced, under the plea that computerisation leads to better productivity. While the argument of computerisation leading to higher productivity is true in general; it is not automatically applicable if the underlying workflow is not changed. DGFT processes the file manually even today, with each file moving along with the notes like a normal, non-computerised, file. The workload has also increased in recent years with number of applications peaking with the recently expired quinquennial policy. 

Therefore, the following might be a proposal worth consideration/debate:


A risk management system (RMS) on the lines of popular RMSs seen in other departments such as customs/central excise might be envisaged. The idea is to use parameters such as track record of exporters, status of exporter, value of scrip, nature of product and so on, in order to arrive at a risk factor, which then would decide if the file can be processed without any physical verification at RA, and the scrip/authorisation/EODC issued without any scrutiny on self-declaration basis. It goes without saying that there must be a random post-facto verification. Those who fail RMS risk factor have to follow normal work flow which involves scrutiny or processing as done currently. 
RMS can be a software, which runs each time an application is received and arrives at a risk factor. If the number falls in green zone, an automatic approval ensues without any interference, else the file goes through normal route. 

This is elaborated with some imaginary RMS criteria for few work-processes below:

A status holder, who has closed more than 20 EPCG applications in past, may be allowed to close his EPCG cases on self-declaration basis. On submission of documents online/offline, an EODC is generated automatically without any delay. Similar criteria might be adopted in redemption of Advance Authorisation. The criteria might be fine-tuned, but the intent is to reward exporters who are regular, and who know the procedure well enough to have closed enough past cases. 
Fresh AAs/EPCGs: 
Similar criteria may be evolved, and the licenses issued same day online. 

Incentive Scrips: 

Similar to Drawback issue by customs. May issue online scrips based on self declaration for people who meet RMS criteria, and the rest may follow normal workflow till they start ticking RMS criteria.