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All materials copyright of the Wharton School of the University of Pennsylvania. Page 1 of 3
Responding to the Rising Rupee: Why Indian Firms Must Rethink Their Business Models: India Knowledge@Wharton (http://www.ikw.in/)
strong economic growth tended to push the value of China's currency upwards, we have in India a
similar situation. China's economic growth strategy is primarily export-led, so it makes sense that it is
interested in a weak yuan (just as the U.S., trying to minimize its trade imbalance with China, keeps
pushing for a stronger yuan). With a multiple set of objectives, which include containing inflation and
favoring foreign portfolio and direct investment, the Reserve Bank of India can try to stabilize the
currency if there are more buyers than sellers of the rupee, but it may not be able to intervene beyond a
point. My view is that the long-term trajectory of the rupee will continue upwards because the Indian
economy should remain strong. After all, when the economy was liberalized in the early 1990s, no one
would have imagined that India would one day have foreign exchange reserves of almost $230 billion, as
it did earlier this month.
Lessons from Japan
The situation that Indian companies face today is broadly similar to that faced by Japanese firms when
the yen began to appreciate against the dollar during the 1980s. When I first went to Japan in 1981, the
yen was almost 225 to the dollar. But in later years, the yen appreciated to close to 80 to the dollar. Yet
companies like Toyota, even as the yen grew stronger against the dollar, saw their U.S. market share go
higher. How did they manage that, and what lessons does it hold for Indian firms?
I believe there is a strong parallel here from which Indian companies -- especially, though not solely, the
IT firms -- can learn some important lessons. If Indian companies compete mainly on cost arbitrage, they
will find that as their costs rise because of the stronger rupee, they will increasingly become less
profitable. Of course, it is also the case that, as the rupee appreciates, net margins at some companies
erode more than at other firms. Specifically, if Indian IT companies compete as low-cost providers of IT
services, their competitive advantage will erode in a regime of rupee strengthening.
Instead, Indian firms should take advantage of this opportunity to adapt their business models. How can
they do that? While the details of the two industries are quite different, the Japanese automobile industry
can suggest some answers. Consider what leading Japanese firms like Toyota did as the yen strengthened
against the dollar. For product lines where they made the highest margins, such as the Lexus, they
continued production in Japan. However, for lower-priced models -- where their profit margins were
lower and would have been eroded further by the rising yen -- they moved production to the U.S. They
protected their margins on non-premium products by moving production -- and therefore shifting costs --
into dollar-denominated areas. They also reduced their vulnerability to further appreciation of the yen.
You may remember that during the 1980s, Japanese auto makers were facing a protectionist backlash in
the U.S., and they were subjected to import quotas. Their strategy of moving production of
lower-priced/lower-profit cars into the U.S. paid off in a couple of different ways. First, they were able to
shift yen-denominated costs into dollars. Second, this was a quite savvy political move, because although
these companies continued to gain market share in the U.S., there was little pressure to shut down their
plants. Doing so would have meant a loss of American jobs.
I believe Indian companies should take a similar approach in response to this recent rising rupee regime.
They need to consider how to adapt their business models. To the extent that they compete primarily on
cost arbitrage, the rising rupee will work against them. One key question to ask is how to develop other
sources of competitive advantage, such as building high-level capabilities which cannot easily be
replicated by competitors, or how to change the mix of activities carried out in India versus other
countries. Of course, in order to do this, they will have to change their mindset: They will have to stop
thinking of themselves as Indian companies and think more like global companies of Indian origin. They
will need to analyze their portfolio of costs and move production to where it makes the most economic
sense. Notably, Indian IT firms are trying to address rising wage costs by moving productionwithin India
to lower cost regions -- Eastern India (Kolkata, Bhubaneshwar) and to Tier II and Tier III towns.
However, this will only offset a rising rupee to a limited extent, since the costs will still be in rupees.
If Indian firms were to follow this approach, there would be less reason to use the RBI to intervene to
force the rupee down against the dollar. No central bank likes to make big interventions; at best, its role
should be to help bring about an orderly transition between shifts in exchange rates.
In the long run, India will be better off with a stronger currency. Indeed, it may be inevitable. The notion
All materials copyright of the Wharton School of the University of Pennsylvania. Page 2 of 3
Responding to the Rising Rupee: Why Indian Firms Must Rethink Their Business Models: India Knowledge@Wharton (http://www.ikw.in/)
that the RBI can keep the rupee down may not amount in the long term to more than wishful thinking.
The RBI cannot keep the rupee weak indefinitely; the rupee cannot stay down if the Indian economy is
strong and the fundamentals keep pushing it up. Instead, Indian companies should learn to use the
strength of the rupee to their advantage by adapting their business models and geographical mix in
innovative ways.
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