While a depreciating rupee helps boost India’s export competitiveness, rising inflation threatens to undermine it
During the same period, the rupee has fallen by more than 350 bps. Higher REER meant exports were more expensive in FY20, and imports were cheaper—as compared to FY21.
By Rahul Mazumdar
The rupee has been hovering at around 73-74 against the dollar in recent times. It, in fact, has been choppy against other foreign currencies as well. With the second wave, it has weakened compared to the levels reported in the previous year. It depreciated sharply within months with the onset of the pandemic, from 71.54 in January 2020 to 75.59 in May 2020. With the rupee losing significant value against the dollar, the exchange rate can be a possible indicator of the economy’s competitiveness. When the rupee depreciates, it gives a boost to exports as these become cheaper overseas. RBI formulates the rupee’s NEER and REER, providing a monthly weighted index. This is akin to CPI or WPI to show how the prices of goods in general have changed. The index is a basket of six-currencies and 40-currencies (with FY16 as the base year).
REER, however, is considered a better measure than NEER, since it also considers the domestic inflation in the various economies. For this analysis, six major currencies are considered—those of the economies that account for 88% of India’s exports. The Euro has highest trade weight of 12.69, followed by the UAE dirham, the Chinese yuan, and the American dollar at 11.44, 10.84 and 8.8, respectively. A decrease in REER denotes depreciation in rupee’s value, whereas an increase reflects appreciation.
An analysis of the movement of REER over the 24 months between April 2019 and March 2021 gives some interesting results. In India, the first complete lockdown was announced in March 2020. In the 12 months preceding the lockdown—that is, FY20—the average-REER stood at 103.6, much higher than it was during FY21 (at 101.8).
During the same period, the rupee has fallen by more than 350 bps. Higher REER meant exports were more expensive in FY20, and imports were cheaper—as compared to FY21. A decrease, hence, indicates an improvement in trade competitiveness during FY21. The competitiveness of India’s exports got better with REER touching its lowest in 28 months, at 99.68, as the rupee continued to depreciate further. However, the competitiveness of India’s exports, which was showing improvement, may face a hiccup soon due to multiple factors, the primary being inflation. The REER spiked to 100.41 in May 2021; this was one of the fastest such spikes in the last six months.
With the rise in CPI, at 6.3% in both May and June 2021, there will be an upward pressure in the prices of commodities. The continued increase in crude oil prices is expected to add to the fire. Core inflation—the non-food, non-fuel component—was at 6.4% in May 2021, and will be a worrying factor.
While REER has had crests and trough around a limited range between April 2019 and May 2021, the NEER has been mostly declining. REER remains in sync with the inflationary trends—the upward biases in REER due to inflation was already being felt in May 2021. The increasing difference between trends of NEER and REER in the last 26 months was due to India’s domestic inflation being higher relative to the six major currencies considered.
Soaring inflation will impact REER, which, in turn, would inevitably push up the cost of merchandise and affect competitiveness of Indian exports. However, there is a lag period between the fall of the exchange rate and its implication on exports. This is largely because of contracts signed before the exchange rate movements.
With the majority of India’s exports being agricultural products, textiles, jewellery, etc, margins on which are generally small, the rise in inflation will adversely impact these. Such sectors tend to benefit the most when there is a significant depreciation in the rupee. But, this may get offset by related fall in currencies of other emerging markets that are India’s competitors globally. The rupee stood at 74.36 in end-June.
This analysis shows that India’s export competitiveness has improved since FY19, but may lose momentum if inflation continues unabated. Hence, a depreciating rupee alone will not help boost exports.
The author is Senior economist, EXIM Bank
Views are personal
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