Column : India needs a weaker rupee

Nov 16 2012, 02:49 IST
Comments 0
SummaryAs costs of manufacturing goods in India increased more than in our trading partners, it has become cheaper to import.

Currency is considered to be among the best barometers of the economy. An economy with an appreciating currency is commonly perceived to be ‘stronger’ and vice versa. A stronger currency also has tangible benefits. It lowers inflationary pressures by reducing the cost of imported goods. In India’s case, a stronger currency also helps government finances by reducing the cost of fuel and fertiliser subsidies.

No wonder, then, that the clamour has been for RBI to let the rupee strengthen. In May and June, the markets wanted RBI to prevent rupee depreciation by aggressively selling dollars from its foreign exchange reserves. More recently, the markets do not want RBI to prevent the rupee from appreciating by purchasing dollars. The most common argument against currency appreciation is that it hurts exporters by making their products relatively more expensive. But research by Surjit Bhalla, an economist and FE columnist, and others suggests that a weaker currency in a sluggish global growth environment does little to stimulate exports. Even so, a weaker currency is what we need in the current environment—not necessarily to stimulate exports but to restore the competitiveness of the tradables sector.

Judgements about currency levels, as indeed about most other economic variables, need to be made on a real (or inflation-adjusted) basis. India’s relatively higher inflation rates compared to its trading partners (a problem that has only exacerbated in recent years) will mean that even if the nominal value of the rupee remains steady, it will appreciate in real terms. So, while the value of the rupee has been broadly stable in nominal terms from 2004 to 2010 (except during the global financial crisis), it has appreciated in real terms because India’s inflation rates have been higher than those of its trading partners. Both Bank of International Settlements and RBI’s broad measure of real effective exchange rate (REER) show that the rupee was 5-10% overvalued during that time. As a result, India’s tradables sector, especially import-competing sectors, progressively lost competitiveness. Put simply: as costs of manufacturing goods in India increased more than in our trading partners, it has became cheaper to import than to manufacture domestically.

Supporting this analysis is a steady and what appears to be a structural deterioration in India’s merchandise trade balance since 2004-05. The accompanying graphs show the longer-term trend for India’s merchandise trade balance. This data is adjusted for net crude and gold imports. As a result, neither the

Single Page Format
Ads by Google

More from Edit & Columns

Reader´s Comments
| Post a Comment
Please Wait while comments are loading...