New Delhi: In the normal course, a depreciating rupee should have made Indian exports cheaper and more competitive. But instead of celebrating the windfall from a 23% drop in the value of the rupee against the dollar in the last one year, the board of the main exporters’ lobby was busy over the weekend in Goa, charting a plan to deal with the volatile currency.

The uncertainty facing members of the Federation of Indian Export Organisations illustrates the enigma of the macroeconomic fallout of the depreciating rupee.

Because of a combination of shrinking global markets and rising import content of Indian exports, a weakening rupee does not necessarily translate into enhanced exports. Worse, because imports are largely inelastic, with oil and gold accounting for 44% of India’s purchases from overseas, declining exports can only mean that the trade deficit would widen, putting further pressure on the balance of payments.

A price to pay: The rupee depreciation will also put additional pressure on domestic inflation by making imports costlier. Mint

“Both these should have a positive impact on the trade deficit and current account deficit, which is somehow not happening," Sen said.

Perceived policy paralysis and an inability to pursue serious fiscal correction are spooking foreign investors, particularly institutional investors, in a manner that could make the weakening rupee a self-fulfilling prophecy. In other words, there is a risk of capital inflows holding out due to fears of a weakening rupee, which triggers another round of currency depreciation, setting off another round of a negative macroeconomic response. This has resulted in diminished capital inflows, which in turn have only increased the pressure on the rupee, pushing it down to a record low of 56.38 on 24 May.

Sen suggests that the government has to urgently address the worries of foreign investors. “It needs to send a clear message that the present current account deficit of 4% (of gross domestic product, or GDP) is a problem and we are going to address it. It (government) gives an impression that it is not an issue," he said.

A part of the problem is that over the past few years, the composition of India’s exports has changed in favour of value-added products, in contrast with the past when primary products and textiles used to dominate shipments abroad.

While sectors such as engineering, chemicals, and gems and jewellery have been the key drivers of India’s exports, due to a high import content in such products, the depreciation of the rupee does not fully translate into gains for exporters.

Amanpreet Singh Chadha, chairman of EEPC India, confirmed that the rupee’s depreciation is not helping engineering exporters as prices of raw materials and steel have also gone up. Engineering exports accounted for the largest chunk; they were around $75 billion (around 4.2 trillion today) in 2011-12, while total exports were $303 billion.

Pankaj Seth, managing director of Orbit Exports Ltd, a 100 crore company with 75% of its sales accruing in foreign markets, said the rupee depreciation will offset some part of the losses in the short run. However, he added, high inflation has led to hardening of yarn prices, which will hurt textile exports in the medium term. Worse, as Seth pointed out, overseas clients have started seeking discounts on the assumption that Indian exporters are making windfall gains because of the rupee depreciation. “But because of huge volatility, if I promise to sell at 56 per dollar and then rupee comes back to 52 per dollar, it hurts me. We do not know where the rupee will be in next three months’ time." he said.

EEPC India’s Chadha put it this way: “We don’t want a high or low rupee," he said. “We want a stable rupee for the growth of the sector."

Samiran Chakraborty, head of India research at Standard Chartered Bank, said it is a big challenge for an emerging economy such as India to assess the fair value of its currency. “Sometimes, speculators can take the currency far away from its fair value," he said.

The rupee depreciation will also put additional pressure on domestic inflation by making imports costlier. Chakraborty said a 10% depreciation could have an impact of 140 basis points on inflation over a period of time. A basis point is one-hundredth of a percentage point.

Because prices of some of India’s major imports, such as crude oil, have come down in recent times, it has counter-balanced the rupee depreciation. The price of Brent crude oil is down nearly 13% to $107 per barrel in the current quarter, its biggest drop since late 2008.

Debt impact

On account of their aggressive global expansion strategy and the need to find cheaper sources of funds, as opposed to depending on costly domestic credit, Indian companies have taken dollar-denominated loans. The weakening of the rupee is expected to significantly raise their debt burden in rupee terms.

Chakraborty maintains that this is one of the biggest fallouts of the rupee depreciation. “Such companies get very little time to adjust their balance sheets," he added.

And since the depreciation has been sharp, the hedges purchased by some of these companies will not be sufficient to protect them against such losses.

The impact is not uniform. Many information technology (IT) firms do see a benefit in their rupee revenue and, therefore, their margins and profitability, but for quite a few quarters now, the concern has shifted to the revenue front— particularly in Europe and the US.

“In the short term, there might be a negative impact for some companies depending on their hedge positions," said N. Venkatraman, chief financial officer (CFO) at Sonata Software Ltd.

The CFO of another leading IT company said sharp currency movements can have an impact in the near term, but the business model has the ability to sustain itself in medium term. “As long as we follow a consistent model, we can benefit from both the upside and the downside," he added, speaking on condition of anonymity.

The outlook

Unless circumstances change radically, it looks like the weakness of the rupee is going to be an integral part of the macroeconomy for the immediate future.

Since India is globally more integrated than it was in the past—not just in terms of merchandise trade, but also in the actual movement of people and a rapidly expanding corporate footprint—Indian companies and the larger economy are vulnerable. The uncertainty surrounding Europe, struggling with a debt crisis, has only made the outlook that much bleaker.

C. Rangarajan, chairman of the Prime Minister’s economic advisory council, candidly concedes that the outlook on the external sector is worrying. “If capital flows were adequate even with a high current account deficit, the situation could have been manageable," he said.

A current account deficit that’s above 3% of GDP will be difficult to finance, Rangarajan said, adding that the medium-term target should be to bring the deficit below that level.

According to Standard Chartered’s Chakraborty, if the overall macroeconomic situation does not change, it is likely that the rupee will remain weak. “The global situation is not helping either," he said.

Sridhar K. Chari in Bangalore and Reuters contributed to this story.

This is the first in a five-part series on living with a weak rupee.

Next: Travel and tourists