Depreciating rupee may not boost exports but it is definitely not a cause of concern yet!
By Karan Bhasin
This year has already witnessed the rupee losing approximately 8% compared to the US dollar. For the last couple of months, it was argued that the rupee was indeed overvalued and that a correction was only inevitable. The increase in prices of crude oil had worsened our current account deficit and had also accelerated inflation in the domestic economy. As a consequence, this correction was required to make imports costlier while making our exports competitive.
It is this assertion that is at the centre of the argument that a depreciating rupee would be good for India as it would make Indian goods competitive. In fact, it has also been argued that the weak performance of Indian exports over the last couple of years is the exchange rate (real effective exchange rate) being overvalued thereby making our goods expensive in the international market.
In that context, it is interesting to note that a depreciation of our domestic currency may in fact result in acceleration of inflation and hence make our exports expensive. This occurs because oil is primarily used across all industries and India is a net importer of crude oil. This implies that a weak rupee may not be necessarily good for the Indian Exporters and hence for the Indian Economy. For starters, it is not just the Indian rupee which is becoming weaker compared to the dollar as dollar is strengthening across different currencies. This implies that the specific bounty in the form of export market competitiveness isn’t occurring exclusively for India but it is available across different economies.
The other important issue is to do with the shift towards protectionism with tariffs and reciprocal tariffs being levied. Given that the United States has started a trade war, most countries have started building up reciprocatory tariffs and non-tariff walls to protect their domestic economic activity. Under such a situation, tapping the exports market is not the best possible strategy due to the weakened demand. Thus, there is no doubt about the fact that a depreciating currency is not necessarily good for the export-oriented industry in the domestic country. In fact, in the current context, it is definitely not viable to look outwards as the world looks inwards.
The dollar is becoming stronger due to the trade war which is putting inflationary pressures on the American Economy. The 10-year treasury bond yield is at 3% while most bond traders in the US expect more rate hikes from the fed in subsequent times. These hikes would cause large capital outflows from the emerging market thereby strengthening the dollar in the near term.
However, the question remains if the depreciation of the rupee a cause of concern for the overall growth of the economy. The answer to this is not yet. There are two possible reasons behind this; first is that our domestic fundamentals are rather stable and this macroeconomic stability gives us enough room to absorb such fluctuations in exchange rate. Secondly, the rupee overshot while appreciating last year and it is just correcting and reverting back to its stable value with respect to the broad currency basket. Thus, at least for now we have some cushioning to absorb such external shocks, however we must be adequately be prepared for a prolonged trade-war and open market operations to maintain a managed float.
Karan Bhasin is a Research Associate with Pahle India Foundation. He can be reached at email@example.com. He tweets at @karanbhasin95. Views Personal.