Weaker Currency — the Solution for an Economy Walking a Tight Rope?
‘Rupee is falling against the USD’
Haven’t we Indians often come across this?
The USD/INR that stood at 62 at the commencement of 2015 is now at 73.4.
Nonetheless, does it do any good to the economy and relieve the RBI of some issues?
These freakish covid months left the RBI with a myriad of problems.
Unemployment, dip in exports, and stress on local supply chains. To tackle some of these, the central bank recently announced policies that avoided INR from becoming stronger.
Why would a central bank weaken its own currency?
The prime benefit of having a weaker currency is the increase in export earnings, which motivates many more Indian firms to ramp up local production and make profits by exporting to other countries. The blessing that rolls in is that it increases the economic activity inside a country.
Imagine this, 1 USD = 70 INR before and 1 USD = 73 INR after INR looses value (or weakens). And, you are a chocolate manufacturer based in New Delhi. If chocolates in your industry are worth 10 USD in the international market, you earn 730 INR after RBI’s decision instead of just 700 INR before.
Isn’t it pleasant? You profit 30 INR per chocolate you make. To maximize profits, you would ramp up production, and for a ramp up, you would need more employees behind the machines. You see! it in turn leads to more people getting their jobs back during times of recession periods (like right now).
Another benefit of having a weak currency is that imports into the country become expensive.
Imagine you’re a chocolate lover, willing to import chocolates from Switzerland priced at 10 USD on international markets. Before the weakening of our INR, you had to pay 700 INR, but after the weakening, you would have to pay 730 INR, which means you would need to have deeper pockets
(not possible for every Indian). So, what would you do? A chocoholic would start finding the same satisfaction in local Indian brands. That encourages local chocolate producers to increase their production as they spot a chance here, the opportunity of gaining a market share. Hence, in a way, ramping up local economic activities.
Thrilling, isn’t it?
The GDP of a country has a minimalist formula.
It stands directly proportional to the difference between exports and imports. Economists term it as the ‘trade deficit’ — the amount by which imports exceed exports.
As we observed, the exports increase and imports fall, and hence, it directly contributes to GDP growth. Furthermore, unemployment falls as local production ramps up.
Moreover, as more and more people get employed, incomes increase and so does the demand for products.
That, in turn, leads to more supply of money into the market than the demand which causes inflation. The price of products keeps rising with time.
But does inflation serve better in recovering times?
Imagine this, today you have 100 INR with you that can buy you a can of coke. Tomorrow, due to inflation, 100 INR will only buy you a 3/4th can of coke. This fear of money loosing its value pushes consumers to spend today. Especially during the recovering phases of an economy when consumers still focus on saving, imagining that the worst is yet to come. Moreover, as a person’s spending is another person’s income, the latter becomes able to demand something. This way it kicks off economic activity.
Hence, we see the benefits of having a weaker currency and the reasons why the RBI would be willing to take this stance. However, these actions led India to get shortlisted as a potential currency manipulator by the US Treasury. To be labeled a manipulator by the U.S. Treasury, a country must at least have a $20 billion-plus trade surplus with the U.S., foreign currency intervention exceeding 2% of GDP, and a current account surplus of more than 2% of GDP.
On a positive note, the US treasury commended the RBI for being transparent about its intervention. They also shortlisted countries like China, Italy, Singapore, Korea, Japan, Germany, Thailand, Malaysia, and Taiwan.
Being termed as a currency manipulator does increase caution among global forex market players. It gives more reason to the RBI to reduce its intervention now. Economists have pointed out that appreciating the INR helps in keeping import inflation under check.
Thank you for your time!
