The question has two parts. In first part we need to establish the relationship between exchange rate and economic performance of countries and take a stand whether it is a suitable measure or not. Though, there is no direct linkage between them, but over a short term exchange rate can mislead economic situation. Strong exchange rate for long term can depress economic growth as it makes exports more expensive and imports cheaper thus reducing the demand for domestically produced goods.
In the 2nd part we need to highlight the improving macro-economic condition and then describe the current trade deficit situation in India. India is registering average GDP growth of 7.5% between 2014-15 and 2016-17 being among the best performing state in the world. However, despite growth, the trend shows increasing current account deficit which is primarily due to higher trade deficit.
There are various factors responsible for such trend. Like Subdued external demand, Impact of GST, Increase in commodity prices, Electronic as new oil, No commensurate increase in export value and higher interest rate & bond yields.
Further, conclude by saying that India need to ensure robust credit growth, establish proper infrastructure to facilitate efficient supply chain linkages, capture new export markets and increase investor’s confidence to boost its domestic growth.
The exchange rate is determined independently of the growth rate of the economy. With many variables involved, there is no direct link between the two. However, both can influence each other. Over a short term, a strong exchange rate can be misleading to the overall economic situation because it might be driven by speculation rather than long-term economic improvement. In fact, strong exchange rate can depress economic growth, as it makes exports more expensive and imports cheaper thus, reducing the demand for domestically produced goods. Further, exchange rate does not reflect the economic performance due to domestic consumption of domestically produced goods.
Still, a stronger exchange rate over a long period of time can be considered as a suitable measure for relative economic performance of countries as it generally reflects low inflation level, high competitiveness, greater global demand for products etc.
As such, it is the stability or volatility in exchange rate that closely determines economic performance rather than merely the value of the rate. A stable currency evokes confidence in an economy whereas a volatile currency signifies threats and vulnerability to speculations.
However, India even after displaying improvements in macroeconomic indicators such as registering average GDP growth of 7.5% between 2014- 15 & 2016-17, being among the best performing economies in the world, moderate inflation rates etc., shows increasing trend in Current Account Deficit primarily due to higher trade deficit. In 2017-18, India’s trade deficit increased to US$ 160 billion from US$ 112.4 billion in 2016-17. Various factors are responsible for this situation:
- Subdued external demand: Global economy is still recovering and it is expected to pick up the momentum over the current However, current global regime moving towards protectionism and trade wars does not augur well for global trade.
- Impact of GST – Operational issues in GST such as delays in input tax credit and Integrated Goods and Services Tax (IGST) refunds for exporters is leading to blockage of working capital. Also, unorganized segment has also not been prepared for high compliance burden.
- Increase in commodity prices: Oil imports are now almost over 50% higher by value as compared to last year. Rise in major import items such as oil, gold etc. ends up increasing the trade deficit.
- Electronics as ‘new oil’: Net electronics imports continue to rise unabated accounting for 25 per cent widening of deficit. Unless, government quickly ramps up the electronic production, given its size, it may emerge as the ‘new oil’ for India.
- No commensurate increase in export value: Exports have failed to match the increase in imports, which are increasing riding back on surge in gems and jewelry imports. Further, India is also losing its competitive edge in core categories like textiles and agricultural exports to other countries.
- Higher interest rates and bond yields: This has increased the cost of corporate borrowing making it difficult to service corporate debt and putting highly leveraged corporate balance sheets further at risk.
India needs to take the benefit of the synchronized global recovery through trade facilitation and competitive products. Moving forward, it also needs to ensure robust credit growth, establish proper infrastructure to facilitate efficient supply chain linkages, capture new export markets and increase investors’ confidence to boost its domestic growth.