Why we need to stop worrying about a falling Indian Rupee

After growing at double-digit rates for several months in a row, India's merchandise exports have started showing signs of moderation posting 2.14 percent, 1.6 percent, and 4.8 percent in the last three months, compared to 20-25 percent in the January-June period.

This is happening at a time, the attempts to revive private investment are proving to be rather ineffective, and the recovery in consumption is fragile, at best. With debt-to-GDP ratio breaching 90 percent, and inflation above the Reserve Bank of India (RBI)’s comfort levels, neither fiscal nor monetary policy has any room to support growth.

Given this backdrop, the RBI should focus more on supporting exports and let the rupee steadily weaken against the USD (the currency in which 86 percent of India’s export is denominated), and it should intervene in the forex market only to check sharp fluctuations in rupee-dollar exchange rate.

A weaker rupee makes it cheaper for the foreign buyers, and hence they are incentivised to buy more. That helps exports grow faster. A weaker currency also enables Indian exporters to offer lower prices in an intensely-competitive global marketplace. Moreover, unlike the PLI subsidies which incentivises manufacturing, a weaker currency incentivises exports of all kinds of merchandise as well as services.

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 who can match China in pricing, and scale. An undervalued rupee will strengthen India’s relative attractiveness to be selected as a sourcing hub.

This line of thought has its critics as well, who argue that there is no correlation between depreciation of the rupee and export growth; that if the rupee depreciates, buyers/importers tracking movements in the dollar-rupee exchange rate will ask for discounts that will eat up benefits of a weak currency; that a weak rupee increases the cost of imported inputs that minimises the gains from a weaker currency, and; India’s export competitiveness gets neutralised if other countries also weaken their currencies. In other words, it’s a race to the bottom that benefits the buyers.

Yet China pursued this policy for three decades to give a big push to its exports, and now it’s the world’s largest exporter with its goods exports alone exceeding India’s GDP. Earlier Japan too used an undervalued exchange rate to promote its exports successfully. Many countries knew about it but no other countries including India could match Chinese and Japanese export success. The reason is that a weaker currency is a necessary but not a sufficient condition. For instance, a weaker rupee can’t compensate for damage to the country’s reputation caused by a seller of adulterated drugs that killed 70 children. India will need to do more to achieve its export target of $2 trillion by 2030.

On its own, a depreciating rupee may not help India's exports, but an overvalued currency will certainly hurt them. Further, even if the Indian Rupee doesn't fall against the USD but other currencies do, for instance, if the Chinese Yuan falls against the USD, the Indian Rupee 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.

If the rupee declines by 10 percent, but the price of an Indian merchandise being exported somehow goes up by 10 percent, there would be no improvement in competitive advantage. The beneficial impact of a weaker currency on Indian exports can be neutralised if a competing supplier, say Vietnam, gets into an FTA agreement with a common trade partner, say the US, even if Vietnamese currency doesn’t depreciate against the USD. Many argue that benefits of 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.

Others argue 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 the buyers from developed countries. Most buyers pay you 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.

Thus, the beneficial impact of a weaker rupee depends upon multiple variables such as extent of depreciation in other currencies, inflation differentials, and/or absence/presence of FTAs among trading partners and competitors. At a time when most currencies have weakened against the greenback, defending the Indian Rupee will put India’s exports at a disadvantage that we would want to avoid.