Rupee value and exports in short run

(This post was originally published at the Hindu Business line here)

A belief in weak Rupee

A common belief while the Rupee depreciates against USD is that it would help our exports. This ‘weak rupee shall help exports’ is shown as a positive over various negatives arising out of falling Rupee. There is great attractiveness in the argument supported by textbook economics. Undervalued or depreciated currency acts as a direct subsidy for exports while acting as a punitive tax on imports. China used the undervaluation of currency as an effective international trade tool for decades. The undervaluation doesn’t fall foul with the regional or multilateral agreements in the way export subsidies do. However, given India’s situation, it is doubtful if we can have a conscious control on the level of Rupee anymore in light of the central bank’s mandate getting anchored to inflation control. Till some time ago there were calls to depreciate the rupee through direct intervention to help exports. Thankfully the idea is now on the backburner as the rupee has slid on its own, mostly due to the factors originating abroad. In addition, one can never predict a correct level. Rupee at the level of 60 for one USD might be very competitive for services exports, while it may still be dear at 70 for manufacturing sector. However, a mere weakening of Rupee might not be enough to boost exports, at least not in a significant way when it comes to manufacturing sector due to three possible phenomena discussed here.

Twin mechanism of inputs and value chains

First, India is no longer an isolated market exporting local goods alone. Our exports are tightly linked to imports through twin mechanisms of input import dependence and global value chains. The inputs for two of our leading exports, Petroleum & derived products and gems &jewellery, originate abroad. Crude, rough diamonds, and gold are imported to make these export products. A significant part of our non-petroleum, non-jewelry based manufacturing exports are tightly linked to the global value chains. We import various steel products, automobile parts, engineering and electronic components that are processed and assembled before getting exported.  Except raw material, primary forms and agricultural exports, we have few items where the origin is fully Indian. Given this scenario, any depreciation of our currency works both ways. The gain would be only to the extent of value addition that happens in India. 

The invoice currency curse

Second, there appears to exist a counter-intuitive effect of weak local currency not helping exports that arises due to the choice of invoicing currency (Gopinath, 2015).  Almost all our exports are invoiced in international currencies such as USD, Euro or Pounds. Assume a case where the price of a certain export good is agreed at 100 USD for the coming quarter. The goods are invoiced at this price in USD for all shipments for the quarter. If the Rupee weakens meanwhile, this invoicing method would lead to windfall profits for un-hedged exporter during the period (and commensurate pain if it strengthens), but it does nothing to change the underlying competitiveness. An item, which was invoiced at 100 USD earlier, continues to do so in international markets even after weakening of rupee, unless the terms are renegotiated between the exporter and buyer for the quarter. It is seen from the study that the weak exchange rate effect may take upto two years (http://www.nber.org/papers/w21646.pdf) to trickle down into the local non-invoicing currency. This time zone while prices are renegotiated is the profit zone for Indian exporters. The process of renegotiation and adjustments is a medium to long-term process and therefore we don’t see an immediate advantage in terms of trade despite a fall in value of rupee. There is no change in the level of attractiveness of sourcing from India for an international buyer. Therefore, it doesn’t boost exports in terms of quantity or exports in terms of USD.Only value of exports in terms of Rupee shoots up to the extent of depreciation while the effect lasts. The invoicing of international trade in foreign currency is therefore a disadvantage for us, as it doesn’t let our competitiveness improve automatically and immediately upon depreciation of Rupee. Unless the exporter consciously uses the windfall to mark down the prices, or uses it to boost productivity, there’s not much hope.

However, arising out of the same study, there are further two negativespossible. First, the import costs shoot up almost immediately as the invoicing is done in foreign currency which now needs more Rupees to buy. This leads to inflationary pressurearising out of inelastic imports such as crude for a country like India. Second, it adds to the cost of inputs that go into export products in the value chain, thus eroding margins. There appears to be nothing much we can do about the way the trade invoicing is done in foreign currency.

A weak correlation

Third, there are also doubts about correlation between a weak rupee and manufacturing exports. It was found that a fall in the value of rupee didn’t lead to an expected commensurate gain in manufacturing exports during the period 2004-2012 (http://www.nipfp.org.in/media/medialibrary/2013/04/WP_2013_115.pdf). This weakness in the correlation between a weakening rupee and increase in manufacturing exports may be an outcome of combination of factors, including the integration into global value chains which makes the exports dependent on imports. As the sensitivity to exchange movement is faster on imports, and slower on exports, the weak correlation is not a surprise. At least the Indian experience attests to it. 

In short, one cannot rely on a weak rupee alone to boost exports. We need to look beyond at structural factors and take a sectoral approach to boost competitiveness if the aim is to improve export performance. The central government has taken various steps in this direction, significant among them being the collaboration with the state governments in order to take a micro sectoral approach at the level of clusters and districts. While the steps produce results, we may discount the expectation of a weak Rupee boosting exports.