Weak rupee doesn’t guarantee export boost

The export of a country mainly depends on two factors. First, customer sensitivity to the export price. If export demand is responsive to high prices, then a fall in export prices increases export volumes proportionately, all else being equal. Export revenue, which is the export quantity multiplied by the price, therefore increases.

If all other factors do not remain constant, especially if competitors’ export prices also decline, our export demand and revenue growth, if any, will be low.

Second, export demand depends on the sensitivity of buyers to income, that is, the income elasticity of exports. All else being equal, if the income elasticity of exports is less than one, a fall in the income of buyers leads to a decrease in export demand, but not by much. Conversely, a fall in buyer’s income will reduce export demand and therefore export revenues will drop significantly if the income elasticity is greater than one.

During a global recession, export prices and world income decline. Exporting countries whose exports are highly price-responsive but have less income-sensitive leverage at such times.

In addition, countries with less import content in their exports benefit more when their currency depreciates. Depreciation leads to higher costs for imported inputs, so over-reliance on imported inputs does not bode well during a depreciation episode. Similarly, if domestic inflation is high, the cost of domestic inputs rises sharply, reducing export competitiveness.

Known as the real effective exchange rate (REER), not 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 in domestic and trade-partnering economies.

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

India’s exports are more income sensitive than price sensitive, with their income elasticity found to be more than one (Veermani, 2008; Chinoy and Jain, 2018). Therefore, any export gains from the currency’s depreciation are offset by a decline in export demand due to a decline in global growth. Furthermore, while Indian exports are mostly price sensitive, elasticity has declined over time.

Moreover, based on both 40-currency and 36-currency baskets, as per Reserve Bank of India estimates, India’s REER is stable, meaning there has been no significant export competitive advantage in recent months as against the dollar. Our rupee has depreciated. First, Indian inflation may be higher than that of trading partners, eliminating the impact of rupee’s nominal exchange rate depreciation on price competitiveness. Indeed, India’s consumer price inflation for the year 2021 was 5.1% higher than the average for middle-income countries (4.1%) and high-income countries (2.5%).

Second, while the rupee is losing value against the dollar, the Indian currency has experienced significant appreciation against other major currencies. The rupee depreciated against the dollar every month from January to August 2022 compared to the same month in 2021. In contrast, the rupee has consistently strengthened against other major currencies, including the pound, yen and euro, during the same period. The depreciation against other currencies has offset the depreciation of the Indian currency against the dollar, resulting in little change in the REER.

Moreover, the import content of our exports, especially of the manufacturers, is high (Veeramani and Dhir, 2022). The two exports of petroleum and gems and jewelery which account for a quarter of India’s merchandise exports, are the most import intensive. With India’s increasing participation in global value chains, the import intensity of a range of other products has also increased significantly over the years.

Estimates by the Organization for Economic Co-operation and Development show that the share of foreign value in India’s gross manufactured exports increased from about 16% in 2000 to a peak of 36.5% in 2012. This partly declined to less than 30% by 2018. Due to Indian hike in average import duty rates for inputs in recent years. Despite the recent decline, the import intensity of India’s exports remains high.

When the rupee depreciates, or ad valorem import duty rates rise, the foreign input becomes expensive, the cost of production rises and acts as a tax on exports by the Lerner Symmetry Theorem. Generally, export strategies based on trade security do not work in a world where production processes depend on international supply chain networks. It affects the price competitiveness of manufactured exports more than services.

The price of energy, a major production input that we import, is also expected to remain high for the foreseeable future. In addition, supply-chain disruptions and material shortages are likely to continue due to rising protectionism around the world.

Overall, it is unrealistic to expect that the rupee’s depreciation against the dollar will provide a tailwind to India’s export growth. Evidence from the past global recession also indicates the same.

Is there a silver lining? Given that our exports are driven more by global growth than our export values, Indian exports are likely to bounce back once the global economy recovers.

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

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