What is the issue?
- The rupee has strengthened 4.3% this year and is trading at around 65 per dollar.
- Despite the short term gains of increasing rupee value, it poses some risks for export-dependent sectors.
What are the causes for rupee appreciation?
- Positive growth prospects among major economies created expectations that the rupee would appreciate.
- This encouraged capital inflows, particularly into the equity market.
- This was with the expectation that any rupee appreciation would also result in a proportionate increase in return on investment.
- Further, relaxation in the capital account and lack of intervention by the RBI in regulating foreign capital inflows are also the reasons.
- Mostly short-term in nature, these capital flows have played a major role in strengthening the rupee.
What are the concerns?
- Exports - A higher currency makes a country's exports more expensive and imports cheaper.
- Resultantly, the strengthening rupee is hurting exporters’ competitiveness and earnings.
- This has the potential to create volatility in the external sector of the economy.
- Employment - Many export-dependent industries such as gems and jewellery, textiles, leather and agricultural products are labour-intensive.
- Also, the supply chain of export industries involves millions of SMEs.
- Therefore, a rising rupee and decreasing exports would be unfavourable for employment opportunities as well.
- Services sector - This is also negatively affected, when export earnings are foreign currency-dominated.
- Evidently, in recent years software export, where India has dominated, is experiencing lower profit margins
Why is export-led growth important?
- An export-led growth strategy with appropriate structural reforms (like liberalisation and an open economy) results in sustained productivity-led growth.
- This is because exports promote better resource allocation, efficient management, and technology exchanges.
- Evidently, China followed an export-led growth strategy and increased its participation in global value chains.
- It also led to the expansion of tradable and manufacturing sectors as well as creation of jobs and growth pick up.
What are the challenges to rupee depreciation?
- Among various structural reforms, one of the prime reasons for the success of China’s export-led growth was an under-valued exchange rate.
- However, there are some limitations and challenges for India in employing this strategy.
- The high fiscal deficit and high debt to GDP ratio give the RBI little space to allow the rupee to depreciate by intervening in the forex market.
- Doing so also has the risk of leading to a higher inflation.
- Inflation is a politically sensitive subject and, moreover, RBI has been favouring a stronger rupee to achieve its inflation targeting mandate.
- Because, as a general rule, there is an inverse relationship between inflation and exchange rate of a country.
- Lower inflation lead to increasing purchasing power relative to other currencies and thus in turn lead to an increase in currency value.
What lies ahead?
- A rising rupee is not a bad thing as it has helped contain inflation through cheap imports.
- Also, companies that have foreign currency-denominated debt have been benefitted by rising rupee.
- However, the strategy may not be right to sustain growth in the long run.
- Ensuring a productivity-led growth by pursuing structural reforms across sectors could reduce the inflation concern of rupee depreciation.
- The government and the RBI should step in to correct the mis-alignment in the exchange rate and allow the rupee to depreciate to move towards its true value.
Source: Business Standard
