The taming of the rupee
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Commerce Minister Kamal Nath has sought the prime minister's help on the strengthening rupee. Over the last one month, the rupee has risen sharply. Exporters are raising alarm bells that the rise of the rupee will reduce export growth, shut down industries and raise unemployment. If you are an exporter and your income is in dollars, an appreciation of the rupee-dollar rate would immediately translate into a fall in your rupee income. Instead of USD 10,000 translating into Rs 4.5 lakh at Rs 45 a dollar, it only yields Rs 4 lakh at Rs 40 per dollar. This is the immediate provocation for the protest.
Is the rupee appreciation going to translate into the kind of disaster that is being predicted for exporters? Faced with lower profits, an exporter could try to lower his costs of production. In the longer term, what determines the volume of exports is also the domestic cost of production in comparison to the cost of production in other countries. Further, if India witnesses high inflation, sooner or later this will get reflected in the cost of production. Even if the rupee-dollar rate remains constant, the dollar price of Indian exports must rise if India suffers from inflation.
The 'real effective exchange rate' (REER) puts together fluctuations of exchange rates and inflation rates of various countries. It is measured in a number of ways. The RBI computes a narrow 6-country index and a broader 36-country index with respect to India's major trading partners. The IMF also includes exchange rates and inflation rates of competitor countries. The Bank of International Settlements (BIS) REER uses weights that reflect the latest trading patterns and adjusts for China-Hong Kong.
In the recent period the narrowest index, the RBI 6-country REER, has been showing visible signs of appreciation. This is often used to raise an alarm that India is losing competitiveness. However, neither the broader 36-country index, nor the IMF or BIS indices, are showing appreciation. This means that compared to a few currencies, mainly the dollar and currencies pegged to the dollar that dominate the 6-country index, we have an appreciation, but compared to a wider set of currencies, India has not lost competitiveness.
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