Treat Indian Rupee’s exchange rate as a policy tool to enhance competitiveness of domestic market

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Finance Minister Nirmala Sitharaman made an important point about the exchange rate movements as she highlighted how the ongoing rate hikes cycle in the United States has led to a historically stronger US Dollar. An outcome of this has been that most currencies have felt the pressure of the strengthening dollar, including advanced countries such as UK regions such as EURO. As it happens, the Indian Rupee has appreciated against the British Pound (10.13 percent), Euro (8.12 percent), Japanese Yen (15.38 percent), and the Chinese Renminbi (1.97 percent).

The story today is not about the rupee weakening, but it is about it strengthening in a highly volatile environment. More importantly, it is about the concerns that we should have because of the strength of the rupee at a time when global economy is weak, and growth is slowing. Under such an environment, a stronger currency will further affect our competitiveness, and have adverse effects on the economy through the trade channel.

Therefore, given our intention to adopt a strategy that relies on exports of goods merchandise and services combined with an impetus of promoting domestic manufacturing, it should be our natural revealed preference that our currency is competitive (read as weaker). That it has been strong is a worry, but, unfortunately, the commentariat has not given adequate thought on this issue while the vicious online army has been quick to reduce an important issue to memes.

It will be wise to understand what it means for a currency to be stronger. It implies that the currency has gained value against a broad basket of currencies. The dollar has appreciated against a much broader basket of currencies which is why we know that it has strengthened. The dollar index measures the strength of the currency, and it is at its highest levels. But what about the Indian Rupee?

The Indian Rupee too has strengthened against a broader basket of currencies, but it has strengthened less than the US Dollar. When one currency strengthens more than the other, it appreciates. This does not mean that the currency against which the dollar has appreciated is weaker. That is wrong, misleading, and frankly dishonest given that both the currencies have been gaining strength. Therefore, it is fair to say that the rupee is not weakening, but it is the dollar which is strengthening given that the relative strength is evaluated against a broad basket of currencies.

It is important while discussing the rupee to contrast the previous experience of the US Fed tightening in 2013, which saw the dollar appreciate against the rupee. Back then, India was one of the fragile five economies, and the rupee was in fact weakening because it was losing value against a basket of currencies rather than just the US Dollar.

In contrast, in 2022, the rupee has been strengthening, and India’s growth is having a disproportionate impact on the global economic growth. This in itself shows the change in India’s relative macroeconomic fundamentals, and robustness of India’s growth process. This robustness comes with the backdrop of a large exogenous shock in the form of the pandemic, and it is largely an outcome of the sound economic policies pursued by the Indian government since the start of the pandemic.

Given that our competitors have witnessed a higher depreciation of their currencies against the US dollars, Indian exporters are automatically less competitive in the international market. This creates an added constraint to India’s growth process, more so when it comes at a time of a growth slowdown and a potential global recession. Under such circumstances, India’s exports growth is expected to be muted and misaligned currencies would invariably end up shifting the business to other countries.

In addition, based on prior evidence there is a recognition that some countries use their exchange rates as a policy tool to enhance competitiveness of their domestic industry in a bid to pursue greater exports. This tendency to rely on exchange rates increases during growth slowdown years. It is, therefore, important to recognise that the rupee has strengthened, and we must be worried about its implications for our growth prospects.

Karan Bhasin is a New-York based economist. Twitter: @karanbhasin95. Views are personal, and do not represent the stand of this publication.