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[op-ed snap] A strong rupee hurts the economy

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Mains Paper 3: Economy | Growth

Q.) “A more appropriate exchange rate would stimulate exports and dampen imports, just as it would help domestic manufacturing firms to be more competitive.” Upto what extent, this statement is correct from Indian Economy perspective.

From UPSC perspective, the following things are important:

Prelims level: Concepts of Devaluation and Overvaluation

Mains level: The article comprehensively explains the effects of Exchange Rates on Economy.


News

Context

  1. The article talks about the effects of strong and weak rupee on Indian Economy

Rupee is becoming stronger

  1. Recently, the exchange rate of the rupee rose to Rs 63.50 per US dollar
  2. According to some analysts, the rate might climb down to Rs 60 per dollar by end-2017
  3. This might be a source of joy and pride for a few
  4. But the objective to increase investment, create employment and foster growth could become difficult to achieve

Why is Rupee price important for Indian Economy?

  1.  It is a determinant of the price competitiveness of exports in world markets and the price competitiveness of imports in the domestic market
  2. Similarly, it exercises an important influence on the profitability of domestic firms that produce goods which are exported, or produce goods which compete with imports

Effects of Overvaluation and Undervaluation
(1)Overvaluation

  1. Overvaluation of the rupee means that its price in terms of foreign currencies is too high, compared to what it would be with a more appropriate exchange rate
  2. This makes our exports expensive in foreign markets and our imports cheap in the home market

(2)Undervaluation

  1. Undervaluation of the rupee means the opposite of Overvaluation
  2. It means the price of rupee in terms of foreign currencies is too low, so that it discriminates against imports and in favour of exports

India’s export performance in the past three years

  1. During the period 2011-12 to 2013-14, average annual exports were $307 billion
  2. Total exports were $310 billion in 2014-15, $262 billion in 2015-16 and $275 billion in 2016-17
  3. Thus, there was a stagnation followed by decline in the value of exports in current prices at market exchange rates
  4. Main Reason: Strong Rupee is one of the main reason behind this decline
  5. The exchange rate of the rupee has been the main culprit in recent years

Effects of strong rupee on Indian Imports

  1. Strong rupee made imports distinctly cheaper than home-produced goods, whether fruits, mobile phones, consumer electronics or household goods
  2. It has increased the presence of Chinese products in Indian Market

Impact of portfolio investment on Exchange Rate

  1. Portfolio investment flows have a significant impact on the exchange rate
  2. Large portfolio inflows lead to an appreciation of the rupee and large outflows lead to a depreciation of the rupee

Impact of high interest rates on Growth

  1. Why high: Interest rates have been kept at high levels in India to combat inflation(supposedly)
  2. Also, it is being done to ensure profitability of short-term foreign capital inflows and maintain confidence in international financial markets
  3. These conditions had negative effects on domestic investment in the real sector of the economy, whether agriculture, manufacturing or services
  4. Such effect on domestic investment means that economic growth is slower than it would have been in the absence of high interest rates

The Way Forward

  1. It is essential to recognize that the exchange rate is a price which matters for the economy in many spheres
  2. The overvaluation of the rupee makes exports difficult and imports attractive, it must be corrected
  3. The time has come to let the rupee depreciate not just in nominal but in real terms
  4. The way forward now, is to drop interest rates which would help the exchange rate depreciate
  5. It will stimulate investment and revive exports, which in turn will drive economic growth and employment creation from the demand side
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