By increasing the landed cost of imported crude oil and chemical fertilisers among others, a weaker rupee aids inflation. It also jacks up the rupee cost of servicing foreign debts and over-burdens students going abroad for studies. Little wonder that the Indian Government is at the receiving end for allowing the Indian rupee (INR) falling to 83 to a dollar. Critics argue that a weaker currency signals a weaker economy, and hence the government and RBI must do something to stop the slide of INR.
However, a weaker currency doesn't necessarily signal a weaker economy as the INR-USD exchange rate depends on multiple factors such as exports, imports, and US Fed actions on interest rates, not all within the control of the RBI and the government. Adding to the complication is the role of market sentiments that strongly influence movement of capital, and in turn, exchange rate.
Moreover, a weaker currency, accompanied by other supportive policies, a proactive use of FTAs in particular, can help overcome the limitations of a smaller domestic market through promotion of exports and enabling domestic businesses to realise the benefits of economies of scale. Thus, rather than being disadvantageous, a weaker rupee can be advantageous especially when India’s exports are faced with multiple head-winds such as increasing inward orientation and worsening global slowdown.
As of now, there is too much focus on the USD-INR exchange rate as the rupee has steadily been depreciating against the dollar. However, what is not getting much attention is that INR has actually appreciated against Euro, GBP and Japanese Yen that puts Indian exports (vis-a-vis Vietnam) at a disadvantage, in particular to the European Union with which India does not have an FTA. It’s worth mentioning that together the EU and UK, account for roughly one-fifth of India’s exports.
The Long-Term Benefits
A weaker rupee makes it cheaper for foreign buyers to buy more Made-in-India merchandise. It also enables Indian exporters to offer discounts in an intensely-competitive global marketplace. This is important for a country like India as its export basket is dominated by commodities, undifferentiated products with no real pricing power such as apparel or sport goods that it supplies to American and European retailers.
Given the favourable geopolitical dynamics at present, a weaker rupee will help bring in export-promoting FDI when countries and corporations want to cut their China exposure, and are looking for alternative suppliers that can match China in pricing and scale. An undervalued rupee will strengthen India’s relative attractiveness as a sourcing hub. In contrast, a stronger rupee makes all kinds of manufacturers including MNCs to focus on catering to India’s domestic markets, and neglect exports. That caps India’s GDP growth as export is at least a 10 times bigger opportunity that remains largely untapped.
Critics argue that using the exchange rate to boost exports is nothing but a race to the bottom. If India keeps its currency undervalued, competing countries will do so and its beneficial impact on exports will be neutralised. Yet Japan and China used this route to pursue export-led growth strategies for decades. Besides, favourable geopolitical dynamics increase its relative attractiveness as a policy instrument when there is an increasing focus on friend-shoring instead of buying from the most cost-efficient suppliers.
On its own, a depreciating rupee may not help India's exports, but an overvalued currency will certainly hurt them. Further, even if INR doesn't fall against USD but other currencies do, INR will become relatively stronger (even if there is absolutely no change in rupee-dollar rate), and that will put Indian exports at a disadvantage in, say, the US market.
Other Factors
Nevertheless, one must note that a weaker currency is a necessary but not a sufficient condition for boosting exports. Inflation can dilute its beneficial impact. A weaker rupee can’t compensate for damage to the country’s reputation as a supplier caused by poor quality ingredients in food products, or unsafe medicines.
It can be argued that the benefits of a weakening currency on exports are neutralised by increased cost of imported inputs. This is correct only if there is no value addition to imported inputs. Similarly, the beneficial impact of a weaker currency on Indian exports can be diluted if a competing supplier, say Vietnam, gets into an FTA agreement with a common trade partner, say EU (while India doesn’t), even if Vietnamese Dong doesn’t depreciate against the Euro.
The other counter argument is that if the rupee weakens, the buyer asks for discounts that neutralises most of the gains from a weaker currency. This is not true at least in the case of buyers from developed countries. Most buyers pay based on contracted dollar or euro value. If the rupee weakens they don’t ask for discounts. Similarly, if the rupee strengthens they don’t offer to pay more. If the price terms change, tracking movements in exchange rates, it’s only for new contracts; so exporters don’t really lose.
Another major criticism is that a weaker rupee will worsen India’s inflation woes. However, RBI’s estimates show that not more than 10 percent of the inflation (60 basis points out of 6 percent) can be attributed to currency depreciation. Yet another contention is that it raises the rupee cost of borrowing abroad. That’s not wrong, but multiple rate hikes by the US Fed and other central banks have reduced the attractiveness of external commercial borrowings.
Import Duties Vs Weaker Rupee
Again, between opaque import tariffs and a weaker rupee, the latter should be preferred as it safeguards domestic businesses from dumped imports in a transparent and non-discriminatory way. At the same time, it incentivises exports and forces local businesses to seek and develop local suppliers of inputs and intermediates, and in turn helps deepen manufacturing.
Thus, a car manufacturer such as Maruti Suzuki (with larger share of domestic sales in its total sales) will try to minimise its production costs by sourcing locally if it expects the rupee to continue weakening. Import duties can have the same effect. But they don't incentivise exports. Instead, they may discourage it by increasing the relative attraction of the domestic markets.
There are other issues with import tariffs. They penalise domestic sales that often cross-subsidise exports which tend to have lower margins. A weaker rupee also does the same, but it compensates businesses by improving export price competitiveness and thus encourages businesses to push exports. Moreover, unlike PLI subsidies which incentivise manufacturing, a weaker currency incentivises export of all kinds of manufactured goods as well as services.
In sum, the benefits of a weaker rupee far exceed its costs.
Ritesh Kumar Singh is a business economist and CEO, Indonomics Consulting Private Limited, a policy research and advisory startup. He tweets@RiteshEconomist.
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