Rupee weakens – Why this could be a blessing in disguise for India…

Back in December 2016, the INR had corrected to around Rs.68.5/$. At that point of time, most analysts were expecting a level of Rs.72/$, which would have been reasonable from an REER point of view. However, as the US Fed became more dovish and the impact of demonetization was quite tepid, the INR appreciated all the way to Rs.63.5/$. In the last one week, the INR has slightly weakened to the 64.5/$ mark. While this may be a small shift, it could still be positive for markets. Let us understand why…

The propensity to import… 

What a strong rupee has done in the last few months is to open the gates to greater imports. Over the last 8 years, India’s imports from China have gone up 3-fold. This is largely due to rupee strength. A strong rupee makes imports cheaper and domestic demand finds imports more economical than domestic output. We have seen industries like steel, machinery and radial tires being negatively impacted by dumping from countries like China. While the government has imposed countervailing duties on select products, the answer would be to let the rupee weaken as it will automatically discourage imports. India’s monthly trade deficit has touched $13 billion on an average and the forex reserves may be just about sufficient to cover 10 months of exports. The answer to the rising trade deficit is to shrink imports with a weaker rupee!

Helping the exporters… 

Across the world, many nations have followed a weak currency approach to boost exports. Countries like South Korea, Japan, Taiwan and later China also adopted a cheap currency policy. A weaker rupee will not only shrink imports but also provide a boost to exports. A weak rupee makes Indian exports cheaper for foreign consumers and hence gives a boost to exports. We have seen India’s merchandise exports and services exports remain stagnant for over a year now, despite a pick-up in world trade. This situation can be largely reversed through a weaker rupee! In fact, there have been no big export stories in the last 20 years after software and pharmaceuticals!

Hedging your currency risk…

A strong rupee has another serious downside risk. It lulls businesses into believing that the rupee strength is going to last forever. That drives a lot of foreign currency exposure to remain un-hedged. Typically, importers and foreign currency borrowers are exposed to currency risk in the event of the INR weakening. But when the INR has been steadily appreciating for over 7 months, the natural tendency is to save the hedging costs. That is not a healthy sign as any currency volatility will result in a rush for cover. The weakening of the rupee will force hedging and that will avoid a situation like 2008 or 2013! ©

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