Sunday, June 7, 2009

Indian Rupee depreciation - the positives

Exporters will benefit in the short term

The depreciation of the rupee during the past few days, which has seen the currency reach new depths, has come at a time when the markets are giving mixed signals. One the one hand, the trade data for January 2009 released earlier this week shows that the trade balance has narrowed for the fifth straight month, even as the decline in exports remains a cause for concern.

The negative cue comes from yet another episode of withdrawal of FIIs. While analysts would argue that the latter phenomenon represents nothing more than a cyclical pattern of FIIs’ involvement in the Indian economy , there needs to be a careful monitoring of the assessment made by the fund managers about the Indian economy in the days ahead.

At a broader level, however, the depreciation of the currency brings to the fore several issues. Purists would argue that the currency depreciation should not be a major cause for concern in the short run for it provides an opportunity to the exporters to become more price-competitive.

Such a situation would auger well for the Indian industry as it seeks to step up its exports in the global markets that are in the midst of a slump. At the same time, the weakening of the currency would provide an added dose of protection to the domestic enterprises, especially at a time when these enterprises are smarting under the growing threat of imports from some of India’s major trading partners.

It should, however, be pointed out that the currency depreciation is detrimental to the interests of India’s exporters in the service sector as their export earnings would take a hit. With the economic downturn in the United States showing no signs of abatement, this sector is already under considerable pressure, and therefore, the depreciation of the rupee comes as a double whammy.

But what should worry the policymarkers is the fact that currency depreciation would increase the cost of debt servicing. This dimension needs attention particularly since India’s external debt, which has been creeping up since 2007, has increased by more than a quarter in the first six months of the current fiscal.

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