Rupee@80: The Story Can Get Grimmer”

Source: The post is based on the article “Rupee@80: The story can get grimmer” published in The Times of India on 21^st July 2022.

Syllabus: GS 3 Issues and Challenges pertaining to growth and development of the Indian Economy

Relevance: Indian Rupee Depreciation

News: Recently, The Indian Rupee has dropped to a record below the 80-mark against the dollar.

What are the implications of such a depreciation of the India Rupee?

In contrast to what many are saying that the rupee fall may help the Indian export to grow, the rupee fall may not help our exports. Here’s why.

(1) In the case of depreciation, the exports of price-sensitive commodities do well. But exports of income-sensitive goods may not necessarily do well. Income-sensitive commodities perform well when there is an upsurge in foreign income. But at present, the incomes in foreign countries are under pressure.

(2) At present, there is weak global economic growth due to a surge in inflation. For example, the real GDP growth in the Euro Area and China is expected to fall in 2022.

(3) In the case of India, there is a change in the composition of exports from price-sensitive items such as leather footwear, dairy products, etc., to more income-sensitive items such as refined petroleum products, iron and steel, chemicals, machinery, and transport equipment (engineering goods), and pearls and precious stones such as diamonds.

(4) Therefore, at present, there is a lower demand for income-sensitive items that comprise a major chunk of India’s export basket.

(5) As per the analysis of intra-industry trade (IIT), India is losing out to its competitors, even in exports of price-sensitive commodities. IIT means importing the same line of products, like leather footwear, textiles, and apparel, which a country is exporting, but with different quality.

(a) The quality and value of price-sensitive items that are imported into India are much higher than similar items exported from India.

(b) In India, IIT is becoming more widespread because industrial tariffs have in general gone down across countries. This has promoted overlapping trade flows within the same product categories.

(6) Therefore, India’s major imports like crude oil, precious metals, and coal will continue to cost more as the rupee depreciates.

Expected Trends in the Exchange Market – Rupee is likely to fall further

The Law of One Price (LOOP) theory states that an identical (similar) commodity will cost the same in 2 countries if cost is expressed in a similar currency. It assumes no transport costs and no tariffs on the product. Now, what are the factors that contribute to the reduction of currency value?

(1) Even in the case of LOOP theory, the value of the currency will reduce if Inflation increases.

(2) Domestic inflation is one reason the rupee is under pressure. Further, inflation is unlikely to moderate any time soon due to various reasons:

(a) The recent imposition of GST on pre-packaged food items is likely to increase inflation numbers.

(b) Further imported inflation is not going to ease in the coming days.

(3) Rupee is also under pressure due in the asset markets. Foreign exchange markets, the foreign institutional investors (FIIs) have become the net sellers in the Indian domestic stock market due to high CAD and higher inflationary expectations.

(4) As per the UNCTAD’s World Investment Report, foreign direct investment (FDI) fell by 30% to $45 billion in 2021.