Why India needs a weaker rupee

Jun 10 2014, 04:11 IST
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SummaryAn appreciating currency is politically very seductive. With the emergence of a strong govt at the Centre, capital flows are expected to increase & strengthen the rupee. But the govt should resist this temptation to let the rupee appreciate prematurely

The theoretical understanding is that a weak or depreciated currency increases export competitiveness and results in higher exports. The East Asian experience of Japan, China, Korea and Taiwan reinforces this understanding. It is a well-known fact that China achieved its export-led double-digit growth by keeping its exchange rate deliberately undervalued. South Korea and Taiwan had experienced sharp export-led growth in the 1960s and 1970s. During the 1950s, both these countries engaged in traditional import substitution policies, with multiple exchange rates, high levels of trade protection, and repressed financial markets. But, by 1960s, the two countries adopted export-oriented policies which included unification of exchange rates accompanied by currency devaluations. These measures together with other policies like duty-free access for exporters to imported inputs, liberalisation of the import regime and public investment in infrastructure and human capital helped exports to take off in the mid-1960s, and the high growth rate of exports was sustained in the next two decades. This is the essential core of the widely known East Asian miracle. Chinese exports also took off in early 2000 after the currency was unified in 1998 and effectively depreciated by nearly 30% as China was securing its entry into the WTO. Since then, exports rose by an average of 20% annually, increasing its share in world exports, higher than Japan and overtaking Germany as the world’s largest exporter in 2009.

reflect rupee

reflect rupee

Given the above mentioned success of the East Asian economies, their experience should be attractive to the Indian policymakers. However, the argument has been made that, for various reasons, normally not explained, but relying on past performance, Indian exports do not respond positively to currency depreciation. A simple regression exercise between export growth, global growth and real effective exchange rate (REER—using the consumer prices for calculating the relative inflation ratio) yields a positive correlation between export growth and both rupee appreciation and world GDP growth. Regressing non-oil export earnings with REER also yields similar results. These findings correspond to those found in research reports of JP Morgan, Moody’s and NIPFP research by Bhanumurthy and Sharma. In the paper Impact of Exchange Rate Appreciation on India’s Exports by Veeramani in 2008, it was concluded that “…the appreciation of the REER leads to a fall in the dollar value of India’s merchandise exports. However, the degree of

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