China since the mid-1990s sustained long-term benefits in growth from an export-led manufacturing strategy from a carefully managed exchange rate where the Renminbi (Yuan) remained softly pegged to the U.S. dollar (USD). An under-valued Renminbi helped the Chinese economy to increase its share in the world exports from 1% in 1980 to around 14% in 2016-17.
Japan followed a similar strategy to boost its export demand in the decades prior to the 1990s. However in India’s scenario, a persistent appreciation (i.e. an increase in the value of a currency as against the value of another stronger currency) of the Indian rupee (INR) in recent years has affected the development of India’s export capacity and the demand for Indian products in both the regional and international markets. Inferred from conventional macro-economic wisdom, a higher valued Rupee makes the price of Indian manufactured products and services expensive in a competitive emerging market space (within South and South-East Asia). Tracking the history of the last ten years of the USD-INR parity in Figure 1 (below), one can observe the value of the Indian rupee as it appreciated against the U.
S. dollar. Scholars argue that the current exchange rate reflects an overvalued Rupee. One of the reasons for this trend is closely related with the increasing investor confidence in Indian financial markets from foreign investors who (in recent years) have invested heavily (in form of Foreign Direct Investment and Foreign Institutional Investment). An increase in (foreign) investment consequently increases the demand for the Rupee which in-turn increases its value causing the price of its products (Indian) to go higher over time. While a strengthening of the Rupee in the short-term indicates a growing confidence amongst foreign investors in the currency and the growth of its financial market; nonetheless, if India’s economic policy framework aims at promoting export-intensive products (through schemes like Make in India) across small, medium and large scale enterprises- a more carefully managed exchange rate policy is required in keeping the Rupee more competitive as against the currencies of other emerging market currencies (like that of China, Brazil, South Korea, Philippines etc.
) Figure 1: Historical Trends from Last Ten Years of the U.S. Dollar-Indian Rupee ParitySource: Calculations from Trading Economics In analyzing currency values and exchange rates, one usually monitors the trends in a (host) currency’s nominal exchange rate (i.e. reflecting actual market value of the currency) and the real exchange rate (i.e. adjusting the currency value for inflation).
If we take 2004-05 as the base year (i.e. as a year of comparison), both real and nominal exchange rates in the Indian case reflect a continuous appreciation and overvaluation of the INR-USD parity. Further, in taking the weighted real exchange rate against India’s major trading partners, the Rupee has since remained above where it stood in 2004-05.
Figure 2: A Historical Ten-Year Comparison of USD-CNY and USD-INR Exchange Rate Source: Calculations from Trading Economics In comparison to China (as observed in Figure 2-below), we can observe how India’s exchange rate has appreciated over time while China managed to maintain a under-valued Renminbi i.e. in a way that has made its currency (and its products) cheaper and more competitive in the export markets when it opened up to trade globally. While the factors affecting the volatility of exchange rate may differ from one country to another, a strategic management of exchange rates (as seen in the case of China) kept in alignment with the country’s production patter remains a good example for countries like India to follow in 2018.
Currencies of other exporting (emerging) countries like Philippines and South Korea too have seen a drop in their real exchange rate value since 2013 which has allowed their products to become cheaper and more competitive in the global market.Maintaining a Competitive Exchange Rate PolicyA more constrained or tight monetary policy in the Indian scenario is key in maintaining lower targets of inflation at both the consumer and wholesale price levels. Going forward, it will be vital for both the government and the RBI to not only manage a low inflation rate but also ensure more Rupee-USD exchange rate and keep the rising foreign capital inflows in check. One of the key lessons from the East Asian financial crises that occurred in the late 1990s is that a persistent overvaluation of emerging market currency not only affects its trade competitiveness but also makes the country more vulnerable to a currency crisis in the future. In India’s scenario, a persistent overvaluation has not only affected the export demand but has also increased the overall import cost of goods and services imported from other countries, thereby widening the country’s overall trade deficit and growth. In November 2017, India’s trade deficit increased to around 13.
8 billion USD, the highest deficit since November 2014. After the slump in growth caused from the effects of Goods and Services Tax (GST) and demonetization in 2017, gradual reforms in the exchange rate system during 2018 hold key in improving India’s regional and global trade position. A carefully managed exchange rate (INR-USD) with a gradual loosening of monetary policy (discussed here) may allow the Rupee to gradually depreciate while keeping the inflation or price levels in check. Thus, a well-managed, under-valued exchange rate system backed with appropriate measures in a gradual, time-sensitive manner could be hugely beneficial for India’s growth prospects in 2018 and beyond.