Depreciation of rupees helps exports more than an appreciating currency helping in imports: RBI study

A cost-benefit analysis of exchange rate movements shows that the benefits of depreciation of the Rupee, adjusted for inflation, is more in the form of exports than an appreciation that appears to be better for importers, an RBI study shows. The metric is known as the Real Effective Exchange Rate, (REER).“ The empirical findings indicate that in India depreciation in REER improves trade balance while appreciation deteriorates it” the study titled “Real Effective Exchange Rate and its Implications for India’s Trade Balance” said. The study was published in the Reserve Bank’s latest monthly bulletin.

“ The impact of REER depreciation on trade balance is more than an equivalent REER appreciation in the short-run and vice versa in the long-run”. The views are of the authors Dipak R. Chaudhari, Anshul and Sangeeta Das from the financial markets operations department, Srijashree Sardar from financial stability department and Priyanka Priyadarshini from the department of supervision and not necessarily of the central bank.

The trade-weighted REER assumes that the use of a country’s currency in world trade is closely tied to its share in world trade. In other words, depreciation of a country’s currency vis-à-vis all the trade partners increases the price of imports in domestic currency, making imports costlier and thus reducing demand for foreign goods. At the same time, it also reduces the price of exports in destination country leading to increase in exports.

The RBI computes two REER indices – 40-currency (broad) and 6-currency (narrow) – representing 88 per cent and 40 per cent of India’s trade, respectively. This method used by the researchers suitably reflects the dynamically changing pattern of India’s foreign trade with its major trading partners. Both the indices move in tandem over the long run despite the difference size of basket of currencies in the two indices. The transitory divergence in 40-currency and 6-currency REER during January 2021 to April 2022 was due to higher inflation in the rest of the countries (excluding 6-currency).

In the 6-currency REER, USD and Chinese renminbi each have 28 per cent weight, Euro has 26 per cent, Hong Kong Dollar has 8 per cent, while UK pound and Japanese Yen have equal weights of 5 per cent each.The select 6 currencies had a share of 43 per cent in India’s merchandise export and 37 per cent in merchandise import in 2021-22. The coverage of 6-currency REER and Nominal effective exchange rate (NEER) in total trade increased from 33 per cent in 2012-13 to 43 per cent in 2020-21 before declining to 39 per cent in 2021-22 due to Covid led disruptions. “ The share of imports from these 6 economies has been increasing which may reflect concentration in merchandise imports due to product quality of intermediate inputs among others” the authors said.