Meaningful Minutes

Rupee and export growth

Every time the rupee depreciates, you may notice that the shares of some companies rally in the market. This means that some companies benefit from the fall in rupee’s value against the Dollar. These are usually export-oriented companies earning in foreign currencies. So, when translated to rupees, their profits become higher. This shows that there is a connection between the trade and the rupee. However, India’s exports have continued to fall despite a 6% depreciation of the rupee since January 2015. This shows that the Rupee’s depreciation does not always stimulate export growth

Rupee and other currencies:

The whole picture needs to be seen too. The performance of the currencies of competing export nations matters. A look at the currency chart suggests that of the 21 major currencies (excluding US Dollar), 20 depreciated in value. More importantly, 14 of the currencies fell more than the Indian rupee did against the Dollar since January 2015. This means, the value of goods by competitors turned cheaper in US Dollars. “So while we have gained an advantage versus US producers, other foreign producers may have become even more competitive because their exchange rate has depreciated more,” Raghuram Rajan explained in his speech.

Nominal effective exchange rate:

Another important factor to consider is that India does not just trade in Dollar values. It trades with other countries too. So the rupee’s valuation against other currencies needs to be taken into consideration too. This is done using the Nominal Effective Exchange Rate. NEER compares the Rupee’s performance against a basket of currencies (not just US Dollars). Each of the currency is weighted on the basis of India’s trade with that country. So essentially, NEER balances out any benefits from a gain against one currency with the losses against another currency. For example, the rupee could have depreciated against the Dollar but gained in value against the Euro. Raghuram Rajan compared the Rupee’s NEER with the NEER for all other currencies to gauge if the Rupee and Indian trade performed better or worse than other countries. Data suggests that India has performed just like other countries, i.e., the currency depreciated without causing an improvement in exports.

Real effective exchange rate:

Let’s now add inflation to this (complicated) mixture. Inflation too affects a currency’s value as well as exports. High inflation can push companies out of competition. After all, a continuous rise in costs means companies have to increase prices of goods or risk losses. This, however, makes their goods costlier than goods in another country where inflation is low. So, the NEER is adjusted for inflation in the respective countries to give us a better picture. This is called Real Effective Exchange Rate. The higher the REER, the costlier our goods and services are. Recent data suggests that Indian exports are not very competitive because inflation in India is higher than other countries.