IAS Score

All India PT Mock Test (OMR Based) Across 20 Cities

will be conducted on 6th May and 20th May, 2018. Click here for Test Schedule & Online admission.

Test Center List:

  1. Delhi
  2. Jammu
  3. Chandigarh
  4. Ahmedabad
  5. Bhopal
  6. Lucknow
  7. Allahabad
  8. Patna
  9. Ranchi
  10. Kolkata
  11. Bhubaneswar
  12. Raipur
  13. Jaipur
  14. Mumbai
  15. Pune
  16. Nagpur
  17. Hyderabad
  18. Chennai
  19. Coimbatore
  20. Bengaluru

Declining Exports, Currency War & Free Fall of Rupee: Correlated Impact of the three on Indian Foreign Trade

India's merchandise exports contracted for the 13th month in a row in December. Export contracted by 14.75% in December. India's overall exports are projected by the commerce ministry to decline 13% from the previous year's level to $270 billion in 2015-16, with a trade deficit of around $120-125 billion. The Government's earlier target of $900 billion in exports of goods and services by 2020, raising the country's share in world exports to 3.5% from 2% now, looks more daunting.

Reasons for fall in exports

• Global factors are most important reasons for the slowdown. Due to slow growth in India's export market there is lack of demand for Indian goods.

• Fall in crude oil price has also effected badly India's export earning; Since India is big exporter of refined petroleum products.

• Third most important reason behind the fall in exports is Yuan's Devaluation as  India's top competitor in many of its key exports such as steel, chemicals and textiles is China

• Fourthly, though tariff barrier has decreased over the years in developed countries, the non-tariff barriers have been increasingly used against Indian exports and the most potent weapon of non-tariff barrier is imposition of phytosanitary norms of WTO to restrict Indian export access to these markets.

• Fifthly, in most of the Free Trade Agreement we signed, the other country or bloc is getting more benefits than India, in fact India is getting hurt from some of them in this dealings. For example, India-Asean free trade agreement has hurted India's export of oil palm and textiles because of competition from Indonesia and Vietnam. Further, most of India's preferential trade agreements (PTAs) are shallow in terms of product coverage. For example, the India-Mercosur PTA doesn't include textiles and apparel items, which face prohibitive import duties of up to 35 %.

• While all these external factors have played a role in decline of our factors, however the root cause for this decline is much broader. Despite all attempts at diversification, India's merchandise exports have a narrow base, with the top 20 categories accounting for 78 % of the total. Even in top export categories like textiles, India is exporting low value commodities such as cotton yarn or apparel rather than technical textiles. India's manufacturing exports are fast losing price competiveness, primarily because of poor logistics infrastructure compounded by a weak trade facilitation regime. India's over-dependence on road freight means that the cost of logistics as a percentage of GDP remains as high as 13-14 %, compared with 7-8 % in developed countries. Exports incentives in the range of 2 to 3 % of export value can't fully compensate for the additional cost incurred on account of an inefficient trade infrastructure.

• India's ill-conceived trade pacts have also resulted in inverted duty structure - High import duties on raw materials and intermediates, and lower duties on finished goods - That discourage the production and export of value-added items. Thus, apparel can be imported into India duty free while its raw material -manmade fibers attract an import duty of 10 %. That makes no sense. Similarly, finished products such as laptops or cell phones can be imported more cheaply than all their parts (imported) separately because of duty inversion.

• Lastly, the relative appreciation of rupee against dollar vis-à-vis other currencies like the euro, real, rouble, or Yuan have hamper India's exports competiveness.

What is required to boost India's export?

• Firstly, in short run rupees should be allowed to depreciate more in order to make our exports competitive in comparison to China and other emerging countries.

• Secondly, India should sign FTA giving due weight age to commercial interest also. In recent years India has signed many trade pacts, more for Geo-political reasons than commercial ones which have hurted India's exports, fixing the trade regime should be the top priority for the government.

• Thirdly, India's traditional export market i.e. developed countries in Europe, North America, Japan etc. are either slowing down or they are negotiating Multilateral trade agreements like TPP which would prevent market access to these markets, Therefore in order to ensure long term stability and sustainability of India's exports, India should focus more on African and Latin American Markets by signing more FTA,s in these region.

• Create indigenous sources of supply, where possible, for imports that form parts of exports to provide a cost advantage, or at least reduce the cost disadvantage. Many of India's exports today have significant import components.

• Reduce barriers for foreign direct investment that can provide capital and expertise for export oriented activities.

• Improve domestic infrastructure as; Roads, ports and power.  For example, India is one of the largest producers in the world of fruits and vegetables and the largest producers of milk. Yet, India's share of the world trade in this is less than 1%.  This is attributed largely to lack of investment in post-harvest technology and infrastructure that can deliver these perishables to the world market.

• Tighter regulation for exports subject to international quality control. Note that India is one of the largest exporters of pharmaceutical products. Yet, some Indian companies recently, were handed large fines and also banned by the US and UK regulators for not meeting quality controls. This has the impact of painting a successful industry with the same broad stroke and undermining its potential growth.

Reasons for the Fall of Rupees.

• The Indian Rupees recently touched 3 year low   when Rupee value to 1$ touched the 68 mark. What is more surprising in the present fall of rupees is that this fall is happening despite the fact that oil prices are below $30 barrell, as in 2013 higher oil price was one of the reason for the weakening of Rupees as  India imports 80% of the oil that it consumes. Oil is bought and sold internationally in dollars. When Indian oil marketing companies buy oil they pay in dollars. This pushes up the demand for dollars and drives down the value of the rupee against the dollar.

• Global economic slowdown: This is the major factor which is contributing to both the stock markets and Indian currency fall. China's Yuan devaluation has also been hurting the sentiments globally. China has been witnessing a slowdown. IMF has cited a sharp slowdown in China trade and weak commodity prices that are hammering Brazil and other emerging markets.

• Crude oil prices: US is the biggest importer of crude oil. So when the crude prices go down, it means US will be saving more dollars to buy it, as a result dollar as a currency strengthens, leading to fall of Indian Rupee and other currencies at the forex market.

• FIIs have been in the sell off mode in equity segment for last 3 months. This is due to the end of Fed Tapering. During Quantitative easing programme unleashed in USA, FII flow increased tremendously in emerging market because of lower interest rate being offered in USA. With end of Fed tapering the interest rate will increase in USA, which has attracted back FII investors back to USA and other developed countries which are considered safe investment. Due to stagnation in growth rate in most emerging economies, investors are apprehensive that India will also meet the same fate in coming years due to which FII investors are putting their money away from emerging economies.

• India's Trade deficit: Exports contracted for 13th month in a row in December 2015 as outward shipments shrank 14.75% to $22.2 billion amid a global demand slowdown. Imports too plunged 3.88% to $33.9 billion in December over the same month previous year.

• Despite the ongoing depreciation, the Rupee has still performed relatively better this year than other Asian emerging market currencies, having lost about 1.6% against the dollar, compared to a fall of around 3.4 % in the South Korean won and a drop of around 2.3 % in the Malaysian ringgit.

Currency War: An Analysis

• China has devalued its currency twice in last 6 months, many economists believe that it is in response to Quantitative Easing Programme of the USA which has led to depreciation of US dollar against YUAN and affected Chinese exports. This devaluation is termed as maturation of currency war which is prevailing in world economy since last few years.

What is currency war?

•  A currency war refers to a situation where a number of nations seek to deliberately depreciate the value of their domestic currencies in order to stimulate their economies. Although currency depreciation or devaluation is a common occurrence in the foreign exchange market, the hallmark of a currency war is the significant number of nations that may be simultaneously engaged in attempts to devalue their currency at the same time.

• More than 20 countries having reduced interest rates or implemented measures to ease monetary policy from January 2015 and January 2016 , the trillion-dollar question is - are we already in the midst of a currency war?

Why do countries indulge in Currency War?

• It may seem counter-intuitive, but a strong currency is not necessarily in a nation's best interests. A weak domestic currency makes a nation's exports more competitive in global markets and simultaneously makes imports more expensive. Higher export volumes spur economic growth, while pricey imports also have a similar effect because consumers opt for local alternatives to imported products. This improvement in terms of trade generally translates into a lower current account deficit (or a greater current account surplus), higher employment, and faster GDP growth. The stimulative monetary policies that usually result in a weak currency also have a positive impact on the nation's capital and housing markets, which in turn boosts domestic consumption through the wealth effect.

Negative Effects of a Currency War

• Currency depreciation is not the panacea for all economic problems. Brazil is a case in point. The Brazilian real has plunged 48% since 2011, but the steep currency devaluation has been unable to offset other problems such as plunging crude oil and commodity prices, and a widening corruption scandal. As a result, the Brazilian economy is forecast by the IMF to contract 1% in 2015, after barely growing in 2014.

So what are the negative effects of a currency war?

• Currency devaluation may lower productivity in the long-term, since imports of capital equipment and machinery become too expensive for local businesses. If currency depreciation is not accompanied by genuine structural reforms, productivity will eventually suffer.

• The degree of currency depreciation may be greater than what is desired, which may eventually cause rising inflation and capital outflows.

• A currency war may lead to greater protectionism and the erecting of trade barriers, which would impede global trade.

• Competitive devaluation may cause an increase in currency volatility, which in turn would lead to higher hedging costs for companies and possibly deter foreign investment.

Are countries today indulging in currency war?

• The Yuan has lost 5.8% since August 10 when the Chinese central bank devalued the currency. The European Central Bank's (ECB) has promised to further its quantitative easing programme, While recently, Japanese central bank has brought negative interest rate in Japan which is likely to make YEN weaker. Even central bank of many emerging economies like Turkey, Brazil and South Africa are also following easy monetary policy in order to make their currency weak. This has proved that countries are indulging in currency war currently.

Should India indulge in Currency War?

• In 2015, the Rupee has depreciated just about 5% against the dollar, compared with a 20-35% loss in currencies of Brazil, Argentina and Turkey. At the same time, the rupee's peers in Asia have fallen about seven to 9% over the past year. Many experts believe that our lack of indulgence in currency war has led to fall in India's exports and therefore India should indulge in currency war in order to protect our turf. However if we closely analyze we find that Currency war is not a solution for India for number of reasons.

• Currency depreciation is not the panacea for all economic problems. Brazil is a case in point. The Brazilian real has plunged 48% since 2011, but the steep currency devaluation has been unable to offset other problems such as plunging crude oil and commodity prices, and a widening corruption scandal.

• At a time, when India is starved of domestic capital, foreign capital has been a savior. In fact, India has been making all efforts to attract foreign capital. A weak rupee impacts their return on capital and would starve India of foreign capital.

• India's imports are inelastic and therefore a weak currency could lead to Balance of payment crisis.

• We have also seen other negative effects of currency war above, Therefore India not rely on weak currency to boost its growth and exports instead it should focus on doing real reforms including improving infrastructure, labour reforms, passing GST to have a long term stable and sustainable positive effect on growth and trade.

• Key Terms

What is Quantitative Easing (QE) ?

• Quantitative easing is an unconventional monetary policy tool which was used by the Central bank of the USA (Federal Reserve) to boost the economy after the financial crisis of 2007-08.

• The Federal Reserve had to resort to quantitative easing because the conventional monetary policy tools used to control money supply had become ineffective. The main tool of conventional monetary policy in the USA is the federal funds rate. The Federal funds rate is the rate at which banks lend overnight to each other. It is the Inter-bank rate. (In India, the key policy rate is repo rate. Though, its mechanism is not the same as the Federal funds rate. Repo rate is the rate at which RBI lends to the banks against securities

• In the aftermath of the financial crisis, the United States started reducing its federal funds rate to increase the money supply in the economy. It was intended to boost the economy and lower the unemployment rate. By December 2008, interest rates had reached to 0%. It became impossible to cut interest rates further and hence quantitative easing was used.

In quantitative easing, Federal Reserve Bank buys Government bonds and other financial assets from commercial banks to inject cash into the economy. Japan was the 1ST  country to use Quantitative Easing.

From where does the Federal get money to buy bonds?

The money is created electronically and credited in the reserves accounts of the banks.

When Federal buys bonds from the bank, it increases its reserves. Banks have to keep a certain percentage of deposits as reserves with the Federal. Increasing the reserves lets banks lend more money as now it has extra reserves parked with the Federal.

How does Quantitative Easing work?

Quantitative Easing is the buying of Government bonds from the banks. It has the following effects:

• The price of the bonds increases as its demand increases.

• Their interest rates reduce.

• Bank has more money kept as reserves than it is required. It can lend this money to consumers and businesses. Hence, money supply in the economy increases.


More In This Section

Quick Contact