A weaker rupee doesn’t guarantee export boost

For more than a month now, one US dollar has been exchanged for more than 80 Indian rupees. The value of the rupee has more than halved since early 2008. Would rupee depreciation help raise exports and provide a cushion for India’s economic growth during the global slowdown that is upon us?

A country’s exports primarily depend on two factors. First, customer sensitivity to the export price. If export demand is highly price responsive, then a decrease in export prices raises export quantity more than proportionately, all else remaining the same. Export revenue, which is export quantity multiplied by price, therefore rises.

If all other factors do not remain constant, especially if the export prices of competitors also decline, then the increase in our export demand and revenue, if any, would be less.

Second, export demand depends on sensitivity to buyers’ incomes, namely the income elasticity of exports. All else remaining the same, if the income elasticity of exports is less than one, then a decline in buyers’ incomes leads to a reduction in export demand, but not too much. In contrast, a decline in buyers’ income would reduce export demand and therefore export revenue significantly if the income elasticity is greater than one.

During a global downturn, export prices and world income tend to fall. Exporting countries whose exports are highly price-responsive but less income-sensitive benefit during such times.

Further, countries with lower import content in their exports benefit more when their currency depreciates. Depreciation leads to higher costs for imported inputs, so higher reliance on imported inputs does not bode well during depreciation episodes. Similarly, if domestic inflation is higher, then the cost of domestic inputs rises faster, lowering export competitiveness.

What is known as the real effective exchange rate (REER), rather than the nominal exchange rate, therefore, matters more for exports. The REER is the trade-weighted exchange rate of the exporting country’s currency against a basket of foreign currencies adjusted for retail inflation at home and in trade-partner economies.

Now, how do Indian exports fare on the above criteria?

India’s exports are more income sensitive than price sensitive, with their income elasticity found to be greater than one (Veeramani, 2008; Chinoy and Jain, 2018). Any export gain from currency depreciation, therefore, tends to be less than a decline in export demand due to a fall in global growth. Also, while Indian exports are mostly price sensitive, elasticity has declined over time.

Moreover, as per the Reserve Bank of India’s estimates, based on both 40-currency and 36-currency baskets, India’s REER is steady, implying that there has been no significant export competitiveness gain in recent months as our rupee declined against the dollar. First, Indian inflation might have been higher than that in trade partners, nullifying the effect of the rupee’s nominal exchange rate depreciation on price competitiveness. Indeed, for the year 2021, India’s consumer price inflation was higher at 5.1% compared to the averages for middle-income countries (4.1%) and high-income countries (2.5%).

Second, while the rupee has been losing value against the dollar, the Indian currency has experienced noticeable appreciation against other major currencies. The rupee fell against the dollar for every month from January to August 2022 compared to the corresponding months in 2021. In contrast, the rupee has consistently appreciated against other major currencies, including the pound, yen and euro, during the same period. Appreciation against other currencies has offset the Indian currency’s depreciation against the dollar, resulting in little change in the REER.

Further, the import content of our exports, particularly of manufactures, is high (Veeramani and Dhir, 2022). The two exports of petroleum and gems and jewellery that together account for a quarter of India’s goods exports are the most import intensive. With the increased participation of India in global value chains, the import intensity of a range of other products also went up significantly over the years.

Estimates by the Organisation for Economic Cooperation and Development show that the share of foreign value added in India’s gross manufactured exports increased consistently from about 16% in 2000 to the peak of 36.5% in 2012. This declined to less than 30% by 2018, partly due to Indian hikes in average import tariff rates for inputs in recent years. Despite the recent decline, India’s import intensity of exports remains high.

When the rupee depreciates, or ad valorem import tariff rates go up, foreign inputs become costlier, raising the cost of production and acting as a tax on exports, by the Lerner Symmetry Theorem. Generally, an export strategy based on trade protection does not work in a world where production processes depend on international supply chain networks. This affects the price competitiveness of manufactured exports more than that of services.

The price of energy, a key production input that we import, is also expected to remain high for the foreseeable future. Also, supply-chain disruptions and material shortages would likely continue on account of growing protectionism worldwide.

Overall, it is unrealistic to expect that the rupee’s depreciation against the dollar would provide a tailwind to India’s export growth. Evidence from previous global downturns suggests the same.

Is there a silver lining? Given that our exports are driven more by global growth than our export prices, Indian exports will likely zoom again once the global economy recovers.

Praveen Kumar, graduate of Great Lakes Institute of Management, Chennai, contributed to this article

Vidya Mahambare & C. Veeramani are, respectively, professors of economics at Great Lakes Institute of Management, Chennai, and Indira Gandhi Institute of Development Research, Mumbai