A weaker Rupee is a positive sign for manufacturing

Why does India catch a cold every time the rupee sneezes? There is a notion of national pride tied to a strong currency. But it’s not argument grounded in economics. But, ideally, at this point in its economics journey, India should be able to benefit from a depreciating rupee.

Fundamentally, when the rupee declines vis-à-vis the dollar or any other major currency, two things happen: exports become cheaper (more competitive), and imports become more expensive (in theory, less competitive). That should be a good thing for a country whose two most important pillars of policy are to increase the competitiveness of manufacturing – for foreign and domestic markets – and to reduce dependence on imports.

Several countries have followed a deliberate policy of undervaluing their currency to gain a competitive advantage. In recent years, China has been the most notable example.

Much is said about China’s industrial policy, including subsidies, free land and cheap power. But, somehow, less is said about the cornerstone of that policy: a weak renminbi (yuan).

To its first credit, the current government is the first since liberalisation to focus on creating a competitive manufacturing sector. I t is using industrial policy like many countries in East Asia and even the West did, via moderate tariff protection and subsidies such as PLI. A weaker rupee is a positive contributor to that strategy.

But the protracted export pessimism between 1947 and 1991 and of declining manufacturing in the two-and-a-half decades post- 1991, entrenched India’s position as a net importer of goods and services with reasonably big trade deficits. That is why a declining rupee hurts.

The nature of imports is a real challenge. This is a result of decades of resource pessimism, despite being blessed with excellent geology.

India has a large forex reserve that RBI can use to defend the rupee. The exchange rate is fundamentally a price determined by demand and supply. If RBI sells dollars while others sell rupees, it can mitigate deprecation. But at the cost of reserves. And, at best, RBI can smoothen volatility, not the direction of the price.

This action isn’t without side effects. It squeezes liquidity. To ease the pressure on policymakers. The answer is to reduce a import dependence. But 50% of India’s imports are on account of natural resources: oil, gold, diamonds, minerals  nd metals. There is a lot of scope to increase the domestic production of these.

A depreciating rupee will supplement proactive policies on manufacturing and yield results that should help India become a net exporting nation in the medium term.

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